Sukumar Mukhopadhyay: The sum of the parts

Since the Goods and Service Tax is a combination of excise duty, VAT and service tax, it is difficult to see how it can yield more than what the individual taxes yield.

Many people have a habit of eulogising something, which is yet to come. It is much like saying that the grass is greener on the other side of the hedge. In seminars on the Goods and Services Tax (GST) being held in recent weeks we hear of such great expectations being bandied about. Let me clarify here that I am not writing about the different models of GST but on the economic effects of GST, whatever may be the model.

The best that I heard sometime back in a seminar organised by an all-India trade and industry association was that the GST would give us Rs 500,000 crore of extra revenue. Other speakers did not mention the figure but all emphasised the great possibility of the immensely earned extra revenue. This is a complete misconception. Such an idea of the excessive potentiality of revenue comes only from a lack of understanding of what the GST basically consists of. The GST is nothing but a combination of three taxable events, namely, (i) act of manufacture, that is, excise, (ii) act of sale, that is, sales tax or VAT, and (iii) act of providing service, that is, service tax. If these three separate taxable events yield a certain amount of revenue, there is no reason why the combination of the three of them will give more or immensely more revenue. The only difference between the three separate taxes and the GST is that the GST makes the base of tax common for the manufacture and sale of goods and the providing of services. If the size of the economy grows at the same rate of, say, 10 per cent per year, with manufacturing, trade and service sectors growing at various rates, there is no economic reason why revenue from a common base will grow much more than the scenario when the base is divided into three. A combination can never be more than the sum of all the three.

A combination can be better than the three constituents only if it can be proved that by combining them, the compliance itself will improve tremendously. That cannot be proved at all. The structures of Cenvat, VAT and service tax are in no way different from that of the GST because they also work on the VAT principle, that is to say, input duty credit is adjusted with the output duty. The GST, in its basic nature, is no different from them. The scope of evasion in the VAT and GST due to the falsification of invoice will continue. Evasion in a GST regime in EU and many other countries is a matter of concern, and has found substantial place in literature on the subject. Public attitude towards evasion is relevant in the occurrence as well as the estimation of evasion. A UK survey showed that 70 per cent of the sample did not consider it as "morally wrong" to pay a trader in cash who volunteered not to charge VAT and 65 per cent appeared to consider it as acceptable behaviour to take cash for work performed to evade VAT or income tax*. Examining the example of a large number of countries, a recent IMF publication by Liam Ebrill and others has come to the conclusion that the effect of VAT on revenue is not direct but complex and the evidence of VAT increasing revenue is weak**. Here the VAT refers to the GST as all the countries discussed have the GST.

Competitiveness is another issue. It has also been claimed that the GST increases competitiveness. The competitiveness of industry increases only if the cost of production decreases. The cost of production is a function of the cost of buying raw material, capital goods, and of wages, none of which depend on the tax. Tax is a separate element which, in any case, is rebated if it is on the inputs in a VAT system. So there is no reason why the cost of production will go down if there is a GST regime because the situation with there being Cenvat, VAT and service tax separately, is the same. Even if there is no VAT, the tax rate can be suitably adjusted to make the impact on industry friendly towards efficiency, as is the position in the US. In the US, there is no VAT but the tax rate is low and the US industry is highly competitive. Moreover, if this argument is based on the hypothesis that the GST reduces tax, then it is diametrically opposite to the first argument that it hugely increases the revenue. If the revenue increases then the cost in the shape of tax must also increase.

It has also been argued that in a national GST regime all other state taxes such as luxury tax, entry tax, octroi, state excise duty and so on will be subsumed and therefore the tax regime will get smoother. This expectation has no logical basis. If the state governments want to merge all the other taxes with the state VAT, they can do so even now through an agreement in the empowered committee and thereafter by passing a suitable legislation. There is no agreement on that issue even now and therefore there is no reason to believe that there will be an agreement even after the imposition of a national GST. The merging of all the other taxes was talked about even before the VAT was introduced. But it has not materialised even though VAT has now been introduced. Moreover, the state excise duty remains separate, as is the position in the EU and some other countries. The complete merger of other taxes with the GST is a Constitutional issue and it is hardly possible to say that just because the states agree to the ST they will also agree to give up all their rights to tax additionally, as is now permitted by the Constitution.

Some writers have argued that all the controversies about distinguishing between goods and services will vanish once the national GST comes into place. While this distinction will vanish, many others will crop up. The GST does not ward off all controversies about the chargeability of tax as evidenced by the innumerable litigations in the European Court of Justice (ECJ). Whether kids' nappies were to be exempted or not became a huge controversy in the EU. The VAT and GST are highly complicated taxes and are not easy to comprehend. "The idiosyncrasy of the VAT"*** is now a famous expression.

Lastly, it may be remembered that the GST can be a success only if it is properly administered. The Brazilian example has been described as a "patchwork quilt", a "blimp with many chewing gum patches" and a "horrible example" by several authors.

The conclusion is that too much cannot be expected from the GST whatever may be the model. In any case much will depend on its simplicity and efficient implementation which are difficult to achieve in a disparate federal setup.

*Alan A Tait "" Value Added Tax, 1988, page 305 quoting "Cash Sir? That Will Do Very Nicely ...." The Times (London) October 28, 1985
** Modern VAT 2001, IMF, page 33
*** Ben J M Terra "" Systems of Levying a Sales Tax, page 14, VAT Monitor, January 1990

The writer is member (retd), Central Board of Excise & Customs