The Goods and Services Tax (GST) Council meets again in two days. The minutes of its three earlier meetings are still not final. But, reportedly, informal consensus has been reached on many issues. For example, a four-slab tax structure of six, 12, 18 and 26 per cent, not counting the zero rate for exempt items.
Following the path-breaking work of Nobel laureate James Mirrlees, economists broadly agree that indirect taxes should be uniform and the distributional concerns left to direct taxes and benefits transfer. Operationally, exemptions once granted are difficult to withdraw, and multiple rates yielding progressivity of tax incidence and taming inflation are often misplaced beliefs. Thus, the GST Council should reduce the number of rates from five to three, or at most four. “Ought implies can” is an accepted principle in policy advice, but the Council should test the political limits of “can”.
Coverage will be incomplete with electricity, petroleum products, tobacco, alcohol for human consumption, and land and buildings being outside the GST’s purview. Some experts rightly point out that the design of the proposed GST could be improved considerably by moving towards more complete coverage.
Whether or not to introduce an imperfect GST from the next financial year is now a question of academic interest. Section 19 of the Constitution (101st Amendment) Act mandates that GST be implemented within one year of its notification. After a year of its notification, the laws relating to the levy of excise, service tax and VAT (value-added tax) are no longer valid. Under Section 20, the President has the power “to remove difficulties” in implementation, including the time line in transition to the new amended provisions, but it is an emergency provision.
By notifying all the sections of the 101st Amendment Act on September 16, 2016, as Vijay Kelkar, Satya Poddar and V Bhaskar have picturesquely describe, Finance Minister Arun Jaitley has thrown away the steering wheel. GST is almost certainly coming from April 1, 2017.
Initiating reforms that are work in progress or halfway houses is fairly common among countries, including India. Remember CENVAT? Central excise duty, with its roots at least as far back as the 1920s, continued as a gross turnover tax at the manufacturing level well until 1986. The transformation started in 1986, with the modified central value added tax (MODVAT), with set-off for taxes paid on inputs at earlier stages, but only for a few select commodities.
Tax on selected services and tax credit for selected capital goods came in 1994-95, and was extended over time. Though MODVAT was renamed CENVAT in 2000-01 with some rate rationalisation and set-off for all capital goods, input tax credit across goods and services was allowed only from 2004-05. The move to a “negative list”, that is a list of few services not subject to service tax, happened in 2012-13. The long and slow journey from central excise duty to CENVAT took at least 18 years, if not 26.
While policy making is the art of the possible, there are nutty problems associated with the theory of the second best. The theory says that if you have everything to make a paratha except for the oil or ghee, abandon the idea of preparing paratha. Go for, may be, roti instead. The argument that it is better to “do nothing” than “doing something” and hence abandon the proposed GST with its imperfections has not been loud so far.
Perception of the benefits from the extension of the Centre’s tax base to the distribution chain of value addition beyond production, of bringing services under the states’ tax net, having a uniform tax base for the Centre and the states, and elimination of tax export from one state to another has prevailed over the fears about GST’s imperfect design. Expectation is that the proposed GST will benefit the economy and slowly mature over time into a better GST. It is a halfway house, but a movable one. Many see April 1, 2017 as the beginning of a journey in the right direction. Hopefully, not as stretched out as CENVAT’s.
Illustration by Binay Sinha
Second is succumbing to lobbying by vested interests for putting particular goods or services at a lower rate of levy, proliferation of GST rates, and frequent changes in rates. New Zealand introduced a single-rate GST in 1986, and changed this rate only twice, in 1989 and 2010. After introducing the GST in 1990, Canada kept the rates unchanged for 15 years. There should be no changes in rates except for their unification.
Third is the challenge of refund administration. Refunds under GST can be as much as 30-50 per cent of the gross collections. “Flying invoices” by dummy firms, a common problem with GST, have to be checked and eliminated expeditiously. Delays in refunds will result in inefficiencies, particularly in the export sector, and in intense lobbying for knee-jerk solutions.
Fourth is a trust deficit between the Centre and the states or among states. Dual GST requires exchange of information and mutual reliance for administrative purposes. Trust in each other’s competence and integrity is essential. Given that diversity of ground-level competence, development of the necessary trust will require the Centre and the states learning from each other.
Fifth is management of expectations. By boosting productivity and investment, GST is expected to contribute to GDP growth. Estimates vary from 0.5 per cent to as much as two per cent. The impact will depend on the tax rates, which are not settled or publicly known. GST’s impact will tend to be evaluated by a comparison of “before” and “after” GST. But, the salutary impact is neither overnight nor independent of other developments, such as monsoon and global economic development. Transitional problems associated with a new tax cannot be ruled out. Both Canada and New Zealand faced adverse outcomes immediately after the introduction of GST, not because of the GST per se, but other exogenous factors. Building up expectations paves the path for reforms. But, when belied for unrelated and transitory short-run reasons, they spell trouble.
The writer is a former chief economic adviser
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
