Goods and services tax - a letdown?     

The release of the much awaited Goods and Services Tax (GST) discussion paper by the Empowered Committee of State Finance Ministers is a welcome step forward in the reform of the indirect tax regime in India. However, the paper falls far short of expectations. The GST design the State Finance Ministers (SFCSs) have opted for is a compromise, which could prove to be neither good economics nor good politics.

Moreover, in spite of more than three years of deliberations, the paper is an incomplete roadmap for the GST. What it reveals is far less than what is missing.

To start with, it reflects only the views of the SFCs, with only veiled hints at the design of the Centre’s GST. The absence of the Union finance minister from the paper release platform should be a cause of concern, especially if it means a lack of consensus. Complete harmonisation of the Centre and State GSTs is essential for a meaningful reform of the indirect tax system. Without it, the dual GST has the potential to become a tax jungle.

Indications given in the paper that the small trader exemption thresholds for the Centre and State GSTs and for goods and services may not be the same does not bode well for the design for a simple and harmonised GST. The paper lays down only the basic structure of the GST. It does not provide a definitive framework for taxation of services, real estate, oil and gas, and other more complex sectors, which have a significant impact on the structure of the GST.

Even the basic issue of tax base, rates, and exemptions is left open for discussion. The Empowered Government prefers the rate structure to be similar to that for the Value Added Tax (VAT), consisting of a nominal rate for precious metals, a low rate for essential commodities and a standard rate for all other goods and services. However, there is no indication of which items would be exempted and what the rates would be.

The multiplicity of central and state rates would lead to administrative complexities and classification disputes. Exemptions for sectors such as real estate and petroleum would deprive them from claiming a credit for the GST applicable on their capital investments and other business inputs. The resulting tax cascade would create economic distortions and undermine the basic objective of the GST reform.

Indications are the combined Centre and State standard GST rate could be in the range of 16-18 per cent. These rates are not conducive to promoting voluntary compliance at the retail level. Taxation of services at these rates would not be popular. More, they leave no room for future increase in rates for meeting the revenue needs of the governments.

The combined Centre and State revenue-neutral rate could be reduced to as little as 11 per cent if applied to a comprehensive base of all goods and services. This single rate would be almost the same as the lower rate under the proposed multiple rate structure of the Empowered Committee.

The proposed list of existing taxes to be subsumed under the GST is also a political patchwork. Taxes such as octroi, purchase tax on food grains, entertainment tax levied by municipal/local governments, and stamp duties are to continue, despite the fact that they are a source of tax cascading and have significant transaction costs.

With all these gaps and compromises, the GST reform could turn out to be a story of missed opportunities.

Source : Business Standard, India, dated 11/11/2009