It is advisable to shift the GST introduction date to April 2011, and begin preparatory work in earnest.
Perhaps the most important tax reform initiative in the 2009-10 Budget is the reiteration of the commitment to the Goods and Services Tax (GST). The world over, countries have replaced their distorting consumption taxes with value-added taxes on goods and services not only to compensate sharply declining revenues from customs duties but also to minimise distortions and create a competitive business environment. The proposal to convert the prevailing consumption taxes into a GST, therefore, is most welcome to achieve fiscal consolidation as well as minimise distortions. The important issue, however, is the need to get the fundamentals right and prepare well to make the reform successful.
The finance minister in his Budget speech has promised to achieve systemic improvements in the fiscal regime over the next five years. He has endorsed Kautilya’s dictum that taxes should be collected like one collects ripened fruits from the trees or the way bees collect nectar from flowers and spread their pollen without damaging them. In modern parlance, a good tax system should minimise the three costs — the cost of collection, the compliance cost and the cost in terms of distortions in the economy. The cost of distortions is equivalent to the square of the tax rate and, therefore, in order to evolve an efficient tax system it is necessary to broaden the base, reduce the rate, minimise rate differences and have a simple and transparent tax system. Furthermore, for both efficiency and equity reasons, it is necessary to strengthen the tax administration and evolve a strong computer-based information system.
From this viewpoint, a unified GST would have been ideal. However, in a federal polity, the objective of harmonising taxes should be balanced with considerations of fiscal autonomy. Therefore, we will have to settle for the dual GST, one by the Centre and another by the states as agreed to by the Union government and the Empowered Committee of State Finance Ministers. Although this involves higher compliance cost and some inefficiency, it is a landmark reform and hence, should be a priority.
A major tax reform initiative like the introduction of GST requires considerable preparation. The reforms thus far have helped to simplify the “CENVAT” and reduce distortions through the introduction of intra-state VAT. However, considerable preparatory work needs to be done before switching over to GST and the effort involves constitutional changes, reforms in both central and state tax systems and building of the information system. Experience shows that tax reforms undertaken without sufficient preparation can create serious distortions. In India itself, the conversion of central excise duty into a MODVAT in 1986 without any preparation led to a sharp decline in revenues with manufacturers claiming credit or seeking refunds without paying the tax in the first place. This move also complicated the tax administration.
The most important measure required is the Constitutional changes to enable the Centre to levy consumption tax beyond the manufacturing stage and empower the states to levy tax on services. The required policy initiatives at the central level are achieving a measure of convergence in CENVAT rates and converting the selective taxation of services into a general tax with a small list of exemptions for equity or administrative reasons and a small negative list to exclude services with significant externalities. There needs to be conceptual clarity in regard to the taxation of sumptuary items and petroleum products. Equally important is the need to set up a proper computerised information system. The present level of computerisation in the excise and customs department is inadequate to deal with a modern tax like GST.
The reforms required to levy the GST at the state level are equally formidable. As there is already an agreement that the states will be given concurrent service tax powers, it is necessary to negotiate and settle the rules of revenue appropriation. Equally important is the need to finalise the mechanism to deal with inter-state transactions to make the tax destination-based, and the information system to track inter-state transactions. A successful GST requires relieving the taxes on inter-state sales. The Empowered Committee seems to have converged on a system in which the seller in the exporting state will credit the tax on his inter-state sale to the account of the importing state in the bank and the buyer in the importing state will take the input tax credit on the imports based on a digitally signed challan/invoice. If this is the mechanism, then the bankers must be involved in the discussion to ensure that they are capable of and willing to undertake the task competently. Equally important is the information system for inter-state transactions. As the central sales tax will be abolished once GST is introduced, tracking inter-state transactions is critical for the success of GST and an initiative to develop the system should be put in place without any loss of time.
There are other important matters that call for resolution as well. It is necessary to decide central GST and state GST rates, and the system of compensation to those states that may lose revenue when the state GST is levied at a uniform rate. Most importantly, it is necessary to involve all the stakeholders in the reform. In particular, taxpayers should be involved in the discussion before the structure of GST is finalised. A major tax reform like the introduction of GST would also require an institutional arrangement for resolving inter-state and Centre-state issues.
Finally, there is the question of desirability to implement a major reform when the economy is at the bottom of the cycle. In this situation, the reform may result in lower revenues and the tax may be unjustly blamed for this. Therefore, it may be advisable to shift the date to April 2011, while ensuring preparatory work for the reform on a war footing. Indeed, taxes, like death, are inevitable and our endeavour should be to make them at least less painful. Although the finance minister stated in his speech, “…reform is not an event but a process,” it is important to get the fundamentals right. Surely, April 2010 cannot be sacrosanct and the country can wait for another year, but the time should be used well to prepare for the reform.
The author is Director, NIPFP. Comments at mgr@nipfp.org.in. Views are personal
