The Structurally Flawed GST

Relevance: mains: G.S paper III: Indian Economy

Context

The goods and services tax (GST) has been in operation in India since 1 July 2017. More than a year later it is still a work in progress.

Analysis of the Issues

• By 1 May 2018, more than 400 notifications and orders had been issued leading to confusion not only among the public but also the experts

Potential Benefits of GST as per the proponents

1. Increase in the growth rate of the economy
2. Decrease in the rate of inflation
3. Increased tax collection leading to rise in the social sector spending
4. The mitigation of the black economy with potentially more tax collection
5. Improvement in market efficiency leading to the “ease of doing business” and higher level of exports
6. Fiscal gains to the poorer states since the GST is a last point tax.

Contradictory views

• If the collection of an indirect tax rises, then prices will rise rather than fall. It was shown that even if the government goes in for a single revenue neutral rate (RNR) of tax, inflation will rise since the basics and intermediates will have to bear a higher rate of tax.
• It was also shown that if prices rise and the government collects more revenue which is used to keep the budget deficit down, then demand will suffer and growth rate will fall rather than rise.
• Further, given the complexity of the tax, its impact of the black economy is arguably marginal. Reports of businessmen evading taxes are coming in daily. Even the income tax data shows that a large number of those in the tax net show either nil income or very low income
• Theoretically, it is known that all taxes are “distorting.” Each time a tax is levied it creates distortions.
• The proponents of the GST suggest that since a single tax, that is, the GST, replaces 17 different taxes, it would be less distorting than the earlier system. However, most supplies currently under the GST had to bear utmost three or four taxes, and not 17 as claimed.
• Moreover, now with the GST in place there are still three main taxes, namely the central goods and services tax (CGST), the state (union territory) goods and services tax (SGST/UTGST) and the integrated goods and services tax (IGST). There is also a cess on certain items.
• However, many more stages of production and distribution are taxed now. Thus, the number of times a tax is levied in the system now is more than that earlier. Thus, distortions will not decline and efficiency will not rise.
• The claim that the GST leads to greater equity is also debatable. When goods go across the state borders, the tax goes with them. Thus, all the tax accrues to that state government where the final sale takes place. That is why, the GST is called a last point tax.
• With the poorer or less developed states having proportionately less production and more consumption than the better-off states, the former are called the consuming states while the latter are the producing states. The argument goes that the tax collection will be proportionately higher in the consuming states.
• The producing states like Tamil Nadu and Gujarat were worried that they would lose revenue. They agreed to implement the GST only after they were assured by the central government that it would compensate them for five years for any loss of revenue.
• The tax benefit to the poorer/consuming states will get nullified by the fact that these have proportionately more of the unorganised sector which is getting hit badly by the GST. Thus, the loss of incomes and employment would be much more in the consuming states than in the producing states.
• The GST, therefore, undermines fiscal federalism by truncating the autonomy of the states with a “one-size-fits-all” policy. An additional problem in this context is faced by the third tier of the government, that is, the local bodies, which are ignored in this reform of the indirect taxes. Their revenue sources are being curtailed without assigning new ones. This will have deleterious effects for decentralisation.

Not a Simple Tax

• The GST, unlike the erstwhile indirect taxes, is not levied on the “act” of production, sale and so on, but on any “supply” of goods and services.
• Primarily, the confusion around the GST is because of the lack of a holistic view on the part of the policymakers. A very difficult tax is being implemented in a very complex nation where one-size-fits-all is inappropriate.
• The states worried about possible revenue losses have ensured that items such as alcohol for human consumption and petroleum products, that have high revenue earning capacity, are kept out of the purview of GST. Real estate (not all of real estate) and electricity are also kept out of the purview of the GST.
• This is indicative of the lack of faith within the government itself, on the official claim that GST will lead to greater collection of taxes.

High Costs of Implementation

• GST requires keeping track of all the inputs and the tax paid on them and then of all the outputs and tax to be paid on them and that is a herculean task for businesses. For the government it is an even bigger task since it has to aggregate the data from all the activities of all the businesses to ascertain the tax to be collected.
• The collection and processing of such massive volume of data can only be handled by computerisation. Thus, setting up of a large computer network became essential and a GST Network (GSTN) was created.
• To keep track of all the transactions of businesses, a unique identification number GSTIN has been allotted to all those who have registered.
• Further, to keep track of the movements of goods so that tax evasion can be mitigated, an e-way bill is required. Each trucker has to register and obtain a 15-digit number called TRANSIN. Each consignment transported has to carry an e-way bill and the TRANSIN number, among other things.
• Processing this vast amount of data often leads to the systems crashing or slowing down inordinately thus delaying the filing of data by the producers.

Unorganised Sector’s Plight

• It is a common knowledge that the poor and small producers in this country are a part of the unorganised sector, and they cannot cope with the burden of additional taxation.
• The GST being calculated as a VAT, is supposed to be levied on the value addition at each stage of production and distribution. Whatever tax is levied at the earlier stage (on the inputs) is subtracted from the tax due on the current stage of production (output). This lowers the input costs and cheapens the output.
• The small and the micro sectors are out of the GST network (those having revenue’s lower than the threshold), they are not eligible for the ITC (input tax credit) and their input cost becomes higher than that of the large- and medium-scale producers.
• Further, they cannot provide ITC to those purchasing from them. Thus, their selling price would also be higher than that of those who pay GST.
• If now, they register themselves under the GST network, then their accounting costs rise.
• Anyone who is registered under the GST and buys from them will have to pay the taxes that these small units should have otherwise paid. This is called the reverse charge mechanism (RCM) (suspended till September)
• In brief, for the small and the micro sectors, the GST poses severe problems whether they come under GST or stay out of it

The Way Forward

The clue to this lies not only in the design of the GST itself but also in the problems that were encountered in the earlier tax system. Some of the important ones to mention are:

1. The cascading effect of taxes leading to higher effective tax rates
2. Distortions and loss of efficiency due to taxation at all the stages of production and distribution
3. complexities in GST due to ITC and RCM
4. Adverse impact on the unorganised sectors and the poorer states, even though GST is a last point tax.

• It is repeatedly emphasised that even if the GST is collected at all the stages of production and distribution, it is a last point tax. That is, it is collected at each stage of supply but passed on to the final point of sale where it is collected from the consumer. If that is the case, why collect it at all the stages and not just at the final stage?
• After all this complex system of accounting, the tax is collected from the final stage. So, why not eliminate the intervening stages of taxation and levy an ad valorem tax only at the final stage.
• But there could be a problem when a product is both a final and an intermediate one depending on its use. For a household, spices and lentils are final products but for a restaurant, they are raw material or input for the final dish that is served to its customer.
• Some cascading effect will continue when some of the supplies taxed as final goods and services are also used to produce some other goods and services. However, such items where there will be an overlap between final and intermediate items will be small in number. So, the cascading effect will be less than that under the present GST.
• Businesses in the unorganised sectors would benefit because they would not have to register themselves or pay a tax. This advantage would help them compete with the producers in the organised sector.
• In the present GST, each registered business person is required to fill in a host of forms. Before some temporary changes were introduced in the GST, it was calculated that a business operating in 31 states of India would have had to file 37 forms per annum per state making it a total of 1,147 forms annually. In the proposed plan the number of forms and paper work will reduce to one-third of the present.
• Distortions of the markets, resulting from the taxation of each stage of supply would decline substantially since only one stage of the entire chain would be taxed rather than of the multiple stages under the present system.

Conclusions

• The above discussion provides the broad details of a proposed alternative and its advantages over the present GST.
• Along with this reform of the indirect tax, there is an urgent necessity to reform direct taxes to increase the revenue receipts.
• Another reform required in the present GST is that provision needs to be made for the local bodies. Their autonomy is getting truncated in the present GST.
• In brief, the present difficulties in the GST are not just implementation issues but structural ones. So, a new and simplified GST on final goods and services is needed to overcome these and to resolve the problems currently plaguing the economy.