In about a month, India’s new indirect tax system will be rolled out. It has been described as the biggest reform in indirect taxes. India now joins some 160 other countries that already have a Goods and Services Tax (GST).
- it moves the tax system from production to consumption. It covers the gross domestic product (GDP) more comprehensively. Because the tax base is now a much wider set of transactions, hopefully the per capita tax incidence will be lower.
- it eliminates a major bane of cascading, i.e. having to pay tax on tax. It will thus increase efficiency of taxation.
- GST has interlocking incentives for compliance, because our tax incidence, and refund, depends on production of proof of tax paid by our supplier. The paperwork, or rather the computer records, is interlinked in a chain. No one person in the chain can evade tax because it hurts either his vendor or customer.
- the tax burden on industry is coming down in the GST. This is because currently, excise plus State VAT adds up to more than 25%, which will definitely go down.
For these three reasons and many more, the GST is expected to bring many benefits to the economy like higher GDP growth, lower inflation, buoyant tax collections, wider coverage and less tax evasion, and, most importantly, a truly common economic market across the country
The basic premise of tax reforms is to aim for lower rates, simpler code and eliminate exemptions.
- with five slabs of 0%, 5%, 12%, 18%, 28% plus cess, we have increased the chance of classification disputes, discretion and litigation. The high rates encourage tax evasion, distort decisions, and promote wasteful resources into tax avoidance. As the GST Task Force of the Thirteenth Finance Commission has said, multiple rate slabs exacerbate the problem of bracket creep and classification disputes.
(Bracket Creep: A situation where inflation pushes income into higher tax brackets. The result is an increase in income taxes but no increase in real purchasing power)
- Items consumed by the poor are taxed at low rates and luxury goods are taxed at higher rates (politically attractive). But this classification itself is problematic especially in a diverse, fast-evolving economy. For instance, perfumed hair oil may be a luxury item in Bihar but not in Tamil Nadu. It is far too complex to classify goods rigidly as those consumed by the poor and the rich distinctly.
- multiple rates increase cost and complexity. As the task force also pointed out, the cost of auditing the classification of exempt, low rate and high rate slabs across every stage of production, distribution and consumption is very high. Single or few rates are easy to comply with and involve much lower disputes.
- Since almost 60% of India’s GDP is from services, and the rate is moving from 15 to higher, it is quite likely that inflation will inch up (evident in the financial, telecom, hospitality and trade services).
- Potable alcohol, crude oil, natural gas, aviation fuel, diesel, petrol, electricity and real estate are currently out, and States will levy their own taxes on these. Taxes paid on these will not be able to be offset against the GST.
The ideal of a low, single rate and comprehensive total GDP coverage, with a fully IT-enabled compliance system, is a destination still far away. But as Mr. Kelkar himself has said, “the journey of a hundred miles must begin with the first step“.
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