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Perhaps
the most important tax reform initiative in the 2009-10
Budget is the reiteration of the commitment to the Goods
and Services Tax (GST). The world over, countries have
replaced their distorting consumption taxes with
value-added taxes on goods and services not only to
compensate sharply declining revenues from customs duties
but also to minimise distortions and create a competitive
business environment. The proposal to convert the
prevailing consumption taxes into a GST, therefore, is
most welcome to achieve fiscal consolidation as well as
minimise distortions. The important issue, however, is the
need to get the fundamentals right and prepare well to
make the reform successful.
The
finance minister in his Budget speech has promised to
achieve systemic improvements in the fiscal regime over
the next five years. He has endorsed Kautilya’s dictum
that taxes should be collected like one collects ripened
fruits from the trees or the way bees collect nectar from
flowers and spread their pollen without damaging them. In
modern parlance, a good tax system should minimise the
three costs — the cost of collection, the compliance
cost and the cost in terms of distortions in the economy.
The cost of distortions is equivalent to the square of the
tax rate and, therefore, in order to evolve an efficient
tax system it is necessary to broaden the base, reduce the
rate, minimise rate differences and have a simple and
transparent tax system. Furthermore, for both efficiency
and equity reasons, it is necessary to strengthen the tax
administration and evolve a strong computer-based
information system.
From
this viewpoint, a unified GST would have been ideal.
However, in a federal polity, the objective of harmonising
taxes should be balanced with considerations of fiscal
autonomy. Therefore, we will have to settle for the dual
GST, one by the Centre and another by the states as agreed
to by the Union government and the Empowered Committee of
State Finance Ministers. Although this involves higher
compliance cost and some inefficiency, it is a landmark
reform and hence, should be a priority.
A
major tax reform initiative like the introduction of GST
requires considerable preparation. The reforms thus far
have helped to simplify the “CENVAT” and reduce
distortions through the introduction of intra-state VAT.
However, considerable preparatory work needs to be done
before switching over to GST and the effort involves
constitutional changes, reforms in both central and state
tax systems and building of the information system.
Experience shows that tax reforms undertaken without
sufficient preparation can create serious distortions. In
India itself, the conversion of central excise duty into a
MODVAT in 1986 without any preparation led to a sharp
decline in revenues with manufacturers claiming credit or
seeking refunds without paying the tax in the first place.
This move also complicated the tax administration.
The
most important measure required is the Constitutional
changes to enable the Centre to levy consumption tax
beyond the manufacturing stage and empower the states to
levy tax on services. The required policy initiatives at
the central level are achieving a measure of convergence
in CENVAT rates and converting the selective taxation of
services into a general tax with a small list of
exemptions for equity or administrative reasons and a
small negative list to exclude services with significant
externalities. There needs to be conceptual clarity in
regard to the taxation of sumptuary items and petroleum
products. Equally important is the need to set up a proper
computerised information system. The present level of
computerisation in the excise and customs department is
inadequate to deal with a modern tax like GST.
The
reforms required to levy the GST at the state level are
equally formidable. As there is already an agreement that
the states will be given concurrent service tax powers, it
is necessary to negotiate and settle the rules of revenue
appropriation. Equally important is the need to finalise
the mechanism to deal with inter-state transactions to
make the tax destination-based, and the information system
to track inter-state transactions. A successful GST
requires relieving the taxes on inter-state sales. The
Empowered Committee seems to have converged on a system in
which the seller in the exporting state will credit the
tax on his inter-state sale to the account of the
importing state in the bank and the buyer in the importing
state will take the input tax credit on the imports based
on a digitally signed challan/invoice. If this is the
mechanism, then the bankers must be involved in the
discussion to ensure that they are capable of and willing
to undertake the task competently. Equally important is
the information system for inter-state transactions. As
the central sales tax will be abolished once GST is
introduced, tracking inter-state transactions is critical
for the success of GST and an initiative to develop the
system should be put in place without any loss of time.
There
are other important matters that call for resolution as
well. It is necessary to decide central GST and state GST
rates, and the system of compensation to those states that
may lose revenue when the state GST is levied at a uniform
rate. Most importantly, it is necessary to involve all the
stakeholders in the reform. In particular, taxpayers
should be involved in the discussion before the structure
of GST is finalised. A major tax reform like the
introduction of GST would also require an institutional
arrangement for resolving inter-state and Centre-state
issues.
Finally,
there is the question of desirability to implement a major
reform when the economy is at the bottom of the cycle. In
this situation, the reform may result in lower revenues
and the tax may be unjustly blamed for this. Therefore, it
may be advisable to shift the date to April 2011, while
ensuring preparatory work for the reform on a war footing.
Indeed, taxes, like death, are inevitable and our
endeavour should be to make them at least less painful.
Although the finance minister stated in his speech,
“…reform is not an event but a process,” it is
important to get the fundamentals right. Surely, April
2010 cannot be sacrosanct and the country can wait for
another year, but the time should be used well to prepare
for the reform.
Source
:
Business Standard - Mumbai, Maharashtra, India, dated
04/08/2009
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