Progress on GST

Constitutional amendment process should be started

Last week, the parliamentary standing committee on finance released its report on the 115th Constitutional Amendment Bill, which had been referred to it by the government in 2011. This Bill lays out the framework and the implementation plan for a national goods and services tax (GST), which many observers have said will be a fiscal game-changer. It will, on the one hand, streamline the entire indirect tax system by eliminating interstate differentials in tax rates, subsuming a large number of local taxes into an aggregate levy, which, once paid, can be claimed as credit against subsequent tax payments anywhere in the country. On the other, it will incentivise countless producers to enroll themselves into the tax system, because not to do so would now reduce their competitive edge. This will significantly raise the tax-to-GDP ratio. With both production efficiency and tax revenue benefits, one might wonder why the system is taking so long to introduce the new mechanism. The answer, as always, lies in the political economy: while the country as a whole might gain, it is not certain that every state will also do so, leading to scepticism about, and resistance to, the proposal.

By and large, the committee endorsed the concept of the GST and recognised the benefits it will bring relative to the extremely fragmented system that now exists. The overall experience of states with the implementation of the value added tax (VAT) does validate the strong incentive effects for enrolment in this self-enforcing framework. However, it also accepts the argument that a fully harmonised and centrally administered system can be seen as an erosion of states' fiscal autonomy. Its recommendations are essentially an attempt to find a middle ground between the efficiency and political economy dimensions of the issue.

There are two broad categories of suggested improvements. On the financial side, the committee proposes moving away from a single, fixed rate of taxation to a range, within which each state could choose to tax goods and services produced within it. This is the practice within the European Union and appears to be an acceptable compromise. Of course, every state may choose to tax at the ceiling, so it has to be carefully set. Keeping in mind the fears of some states about lower revenues, it suggests a formal and funded compensation mechanism to offset any losses. On the administrative side, it proposes greater powers for the GST Council, essentially insulating it from the central government's discretion, but also keeping it within the boundaries of legislative powers. The states' right to opt out of the system is also sought to be protected. There is little question that the current indirect tax system, in its federal manifestation, is grossly inefficient and an alternative - even after taking these recommendations into account - will almost certainly generate enormous benefits to both commerce and government finances. The government should now quickly move to close the issue and get the amendment process under way.