The Thirteenth Finance Commission Report on the goods and services tax (GST) is a breath of fresh air. It is indeed visionary and comprehensive and truly ‘flawless’ as the authors claim. It comes close to the original concept that Vijay Kelkar outlined in his “Report on Implementation of the Fiscal Responsibility and Budget Management Act, 2003”.
Full endorsement of the destination principle of taxation by shifting the tax base from production to consumption.
These well designed features will result in tremendous simplification and rationalisation of tax structure and could prove to be the tipping point for converting the Indian tax regime from one of the worst to one of the best in the world. It would yield substantial dividends to the Indian economy providing gains within a range of 0.9 to 1.7 per cent of GDP. It will strengthen India as a single common market and provide a stable source of revenue for the states and local governments. The cooperation between the Cente and states in the design and implementation of GST will dawn a new era of cooperative federalism.
One of the interesting features of the report is the creation of a council of state finance ministers, which will be responsible for any modifications to the design of GST and for providing compensation to individual states for any loss in revenues due to GST. This body is an innovative compromise between the fiscal sovereignty of the states and the Centre and the need for harmonisation and cooperation.
While the paper has clearly defined a vision for the new tax regime, there are many hurdles that remain. Even though the model outlined by the Finance Commission is a win-win for both the Centre and the states, the states may be reluctant to take the giant leap that it entails. The states have been skeptical of the adequacy of the 7 per cent to replace their current revenues.
The Finance Commission has spent endless hours to confirm the validity and robustness of this calculations. This rate is indeed adequate to replace the current state taxes and provide some surplus from improved compliance and larger GDP, which has not been factored by the Finance Commission while calculating the rate.
The second concern of the states will be the inclusion of sectors such as real estate and alcohol, which are the exclusive reserve of the states under the current constitutional division of taxation powers. Modern GSTs make no exceptions for such sectors. Their inclusion in GST is essential to eliminate cascading and to ensure proper reporting and compliance by all sectors of the economy.
There are also certain technical features in the design of GST, which may prove to be challenging. Most notable among these is the taxation of banking services. No country in the world has been able to design a model for inclusion of financial services within a VAT/GST framework. India, if successful, will chart a new course, which could well become the model, which the rest of the world could emulate.
Overall the Finance Commission has designed a balanced package, which is good for the country, the governments and for taxpayers. It would be fitting finale to the journey of Prime Minister Manmohan Singh to free up the economy from the shackles of regulation and archaic policies.
(The author is Tax Partner, Ernst & Young, India)
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