Roadmap for GST in India

Finance minister P Chidambaram had proposed that India should move towards a national level GST in the Union budget 2006-07, with the Centre and states sharing revenue. He had further proposed to set April 1, 2010 as the date for introducing GST.

The replacement of the cascading and narrowly-based local sales tax with state VAT is the most important tax reform in Independent India. VAT had been introduced on April 1, 2005. Although the dual system of VAT is a good beginning in the reform of commodity taxes in India, in a modern economy, separate taxation of goods and services is not viable.

Though the dual VAT (CenVAT and state VAT) removes some of the weaknesses in the Union excise duties and local sales tax (at the state level), it cannot be the last stage of reforms in commodity taxes in India, as dual VAT in a federal structure will continue to have some cascading effect.

To avoid such cascading effect as well as reduce the transaction cost for manufacturers, it is important that taxes on commodities and services are reassigned in such a way that the powers to levy both these taxes are assigned to the states.

This requires the Centre to withdraw from the field of these taxes for revenue purposes to allow the states levy a comprehensive state GST covering all goods and services. The levy of dual VAT causes vertical tax externality due to taxation of the same base by the two tiers of government. It is important to note the vertical imbalance in the assigned taxation powers under the Indian Constitution.

In the sharing of revenues between the Centre and states, states get only 35%. To remove this imbalance, it is important to rethink about the taxation powers, especially those related to GST.

For this reason, the dual VAT cannot be adopted as a long-term reform measure for domestic trade taxes in a federal structure in India. Thus a comprehensive state GST would be the most appropriate reform.

In India, there are governments at different levels with constitutionally assigned fiscal responsibilities. Fiscal responsibilities are shared by three levels of government — central, state and local. Thus a tax reform by governments at one level can have fiscal consequences for the governments at another level.

Therefore, a tax reform requiring the introduction of VAT in a federation should have the following objectives: it should be revenue neutral between the governments; the tax base should be uniform across the country; the provincial and local governments should have the autonomy to set tax rates; the tax should be relatively simple to administer and to achieve complete compliance; and taxes on the international flows of goods should be based on uniform rules across the country.

Countries like Brazil, Canada, Germany and Mexico as well as the European Union are some of the federations that have adopted VAT. Brazil introduced federal VAT replacing wholesale tax and the state VAT replacing the state turnover tax in 1967.

The tax base for the federal VAT is industrial production. The tax base for the state VAT includes all goods with the exception of some industrial products, imports, agricultural inputs, food products and services. Agriculture, minerals and services are excluded from the tax.

Mexico implemented VAT regime in 1980 to replace 30 federal excise taxes and 400 municipal and state taxes. The tax base covers businesses connected with the sale of goods and services. Mexico has uniform VAT rates and bases across the states and it follows the destination principle. The tax may be regarded as a unified national VAT with revenue sharing.

The European Union (EU) has had a fully harmonised VAT since 1993. Initially it was achieved through the ”approximation“ of rates, i.e., by fixing a specified range within which VAT rates could vary.

The aim of commodity tax reform in India should be a comprehensive VAT covering value added by all business enterprises from the manufacturing to the retailing activities. The tax should be consumption based and follow the tax credit method to compute the net tax liability of a business firm. The tax liability of international and inter-state flows has to be computed by using the destination principle.

A more appropriate reform in India would be to impose a comprehensive state GST like in EU. That would require the Centre to withdraw from the field of VAT. The power to levy VAT rests only with the states. This scheme will avoid duplication by taxing authorities. Since state GST is a comprehensive VAT, including all goods and services (replacing both CenVAT and state VAT), its rate will be adjusted.

The Centre would be compensated this loss arising giving up collecting VAT by authorising the levy of sumptuary excises on a few select commodities.

A comprehensive VAT with the consumption base, tax credit method and the destination principle to determine VAT on international and inter-state flows can be an ideal commodity tax structure for India.

Source : Economic Times - Gurgaon,  Haryana, India, dated 09/01/2008