Eleven years after it was first proposed, a unified Goods and Services Tax (GST) is now nearing reality for the Indian economy. Hailed as one of the most significant reforms to the Indian economy since liberalisation in 1991, GST is a tool to create a well-rooted single market.
The new taxation regime, which is set for a rollout on July 1st, 2017, will replace the various indirect taxes across India’s states with a single national tax on the manufacture, sale and consumption of goods and services. With the passing of the GST bill (the 122nd amendment to the Indian Constitution) in the lower house on March 29th, 2017, the bill will visit 15 out of 29 Indian states for approval as per Article 368 of the Indian Constitution.
India’s Current Taxation Regime
Up until now, the Indian constitution did not provide autonomous power to either the central or state governments to tax the supply of goods and services. Both central and state governments enjoy independent rights to levy tax in exclusive areas of the economy. The central government has sole power to levy income tax, a direct tax on company profits and personal income. Indirect taxes, on the other hand, empower the central government to tax goods and services during the production stage. It also allows state governments to tax the sale of goods and consumption. However, the aforementioned arrangement is laden with problems. Taxation at the manufacturing level, known as Central Excise Tax, has significant definitional and valuation issues. It is hard to define what includes manufacturing and to determine the value on which the tax is levied.
The complexity of the existing tax system leads to tax cascading effects, which are exacerbated by the Central Sales Tax (CST) or Inter-State Sales. For example, a t-shirt manufactured in Haryana (a North Indian state) and sold in Tamil Nadu (a South Indian state) would be considered an “export” by the state of Haryana. Consequently, Haryana would collect CST.
However, the practice of state entry taxes, which causes delays and disrupts the movement of goods, leads to higher logistics, transportation, labour and administration costs for businesses. India’s consumers have to bear the costs of complex inter-state economic activity because of their lack of awareness of the extent to which hidden taxes are paid on goods.
What Is the GST?
The GST is a concept in which all indirect taxes, whether levied by the central government or state governments, will be subsumed as one tax shared by both central and state governments. GST, just like Value Added Tax (VAT), taxes value addition at each stage of the supply chain. In its foundation, GST is based on the same principles as VAT. However, due to taxing technicalities, VAT only applies to goods, whereas services are taxed separately. In the current technological era, it is problematic to distinguish a good from a service so GST aims to resolve this by taxing goods and services together. Central GST (CGST) and State GST (SGST) will be levied on intra-state supply, whereas Integrated GST (IGST) will be levied on inter-state supply by the central government.
Overall, there will be a significant reduction in manufacturing costs due to a reduced tax burden on businesses during manufacturing, wholesale and retail stages. Businesses will also be entitled to an input tax credit, which can be availed if goods and services are intended for the furtherance of a business. As the Modi government aims to increase the ease of doing business in India, GST will act as a catalyst by lowering the cost of doing business.
Abolishing tax cascading effects may lead to lower long-term prices for consumers. Goods and Services will be taxed at the point of consumption rather than production, which means that the destination state will collect SGST paid by its residents. Due to the easy framework of GST and a lower tax burden on the end consumer because of a reduction in manufacturing costs, tax compliance should improve. The tax burden will be divided between manufacturing and services by increasing the tax base and minimising exemptions.
The GST council finalised the tax rates at 5%, 12%, 18% and 28%, with a provision to increase rates to as high as 40%. India is estimated to gain $15bn per annum after implementing the GST. More than 50% of the goods in the Consumer Price Index (CPI) basket are expected to be exempt under GST in order to insulate residents from inflationary pressure. However, GST faces enormous challenges, some of which have been addressed by the central government.
The Immediate Impact
Arun Jaitley, the finance minister of India, said:
“GST has the potential to push India’s GDP by one to two percent”
A contribution from a variety of factors will help GST to boost private investment in India’s economy. Firstly, GST will have a clear impact on tax evasion by creating a mandatory paper trail, thus curbing domestic black money. PAN (Permanent Account Number) and Aadhar, a national biometric identity card, will have to be used more frequently when filing tax returns. As a consequence, the income tax department will be able to track transactions, which is currently not possible.
The incentive for tax evasion will decrease as businesses bear tax only on the value-addition as opposed to taxes on the entire underlying value of goods and services. GST will ultimately act as a self-policing tool which will deter the commonplace practice of selling goods without invoices. Hence, in the long-run, GST will help broaden India’s tax base, add revenue and potentially lower future tax rates.
Secondly, the GST implementation will lead to lower taxes on a large basket of consumer and essential goods, which will drive prices down and lead to a growth in demand for consumer goods. Such an increase in demand should attract private investment in a few key sectors.
Furthermore, for businesses, the GST will help reduce logistics costs incurred at multiple checkpoints across states. This will contribute to a seamless movement of goods within India’s domestic market. The GST will also even out the tax collected per capita across various states. Currently, manufacturing states like Maharastra and Gujarat are richer because more taxes were collected from their production hubs. However, states like Bihar lag far behind due to a dearth of production capacity. As GST is consumption based, a densely populated state like Bihar, with high consumption by a large population, are expected to receive higher taxes. As a result, under-developed states will acquire the necessary economic impetus, as desired by the Modi government.
Firstly, the GST has faced severe criticism for a hasty implementation, which could lead to potential imperfections in structure. The rushed implementation can work against small and medium Enterprises (SMEs), who will likely struggle with unfamiliar electronic filing. Inability to avail credit online will potentially have a negative impact small businesses. Former finance minister, P Chidambaram, said:
“…it can be made less imperfect if you put 70% of the goods and 70% of the services in the rate of 18%. And, if you manage to push 90% of the goods and 90% of the services in the modal rate of 18%, it becomes even less imperfect.”
Most countries like Canada levy tax at a single rate. It can be easily argued that four different tax rates will increase compliance and administrative costs. Global consumption taxes range from 5% to 27%. Harpreet Singh, a partner at KPMG India, said:
“This is not an ideal GST; that would have had just one rate and involved no border checks.”
However, the government has defended its decision and argued that GST rate structure will lower inflation.
Secondly, there is a consensus on the loss of revenue for states, especially manufacturing states. As compensation, the centre has imposed an additional cess (the difference between current tax rate and the highest GST rate of 28%) on sumptuary items. Cess will be used to create a Rs 50,000 crore fund to compensate for revenue losses and will be phased out after five years.
Other concerns include the exclusion of petroleum and liquor from GST, which form a significant portion of India’s total trade. Administrative limitations such as integrating revenue collection services across all states can prove to be a cumbersome task for the Modi government. In addition, the governments of Tamil Nadu, Madhya Pradesh and Chhattisgarh have expressed concerns that they “lack information technology systems and administrative infrastructure required to implement GST”. Bound by article clause 246A, the states lose federal autonomy to change tax rates.
The Future of the Indian economy
India has had a series of interesting economic events in the last six months. Starting with the demonetisation, which allegedly integrated the shadow, informal and parallel economies with the formal, India will now seek to implement GST to further upgrade those efforts. India faces great challenges when it comes to corporate insolvency. By targeting 50 of the most indebted companies and implementing GST, India will seek to tighten some loose ends and set up a solid framework for its flagship, Made In India campaign, by attracting foreign direct investment (FDI). With an aim to take India to the top 50 ranks in terms of ease of doing business, PM Modi would eye an effective implementation of GST and a necessary resolution of non-performing assets (NPA), as means to set up the fiscal structure long awaited for by investors.