The meeting of the empowered committee of state finance ministers and the finance minister of India on July 21 covered substantial ground. The most encouraging development is the all-round acceptance of the need for a common platform for information to support the goods and services tax (GST) regime. This development, by allowing for a common system of filing returns and making payments, would considerably reduce the compliance cost for the taxpayer and provide readily usable information for the departments, thereby enabling them to focus on the more technical and specialised components of the tax administration. Alongside this development, there is evolution in the design of GST.
Other developments, however, are not as encouraging. While the introduction of GST was expected to simplify the design of indirect taxes in India, the proposed regime seems to aim only at an expansion in the base with no rationalisation of the rate structure. The anomalies of the state value added tax regime seem to be getting magnified rather than being reduced.
The Centre as well as the states seem to be looking at three rate categories of GST — apart from the exemption of 99 commodities, the proposal is to introduce a lower rate of basic goods, a standard rate for all other goods and a rate for services. This three-way classification would induce significant scope for classification and valuation disputes and substantially increase the compliance cost for taxpayers. Further, it would provide a fillip to lobbying for lower rates as well. Given the proposed timeline of reducing these rates in the near future, it not clear why both the Centre and states need to maintain this distinction in rates. Even if one level of government were to choose to divide the tax base into three rate categories, the overall rates, too, would remain differentiated. But if the Centre were to opt for a single rate or even two rates by merging the rate for services with the standard rate for goods, the differential between the categories would have been reduced, thereby reducing the arbitrage possibilities from misclassification. It would be useful to reconsider the advantages of fewer rates before finalising the rate structure for GST in India.
The other important issue that requires discussion relates to the persistent arguments of the states to retain autonomy in tax powers, especially to determine rates. The proposed draft of the constitutional amendment suggests that subsequent to the introduction of GST in India, any changes in the design of the tax would require the consent of two-thirds of the members of the council of ministers, as well as the assent of the Union finance minister. Evidently, some of the states are uncomfortable with this approach. It is useful to explore the issues involved here.
First, as there are significant inter-state variations in the tax base, the revenue impact of uniform rate of tax would be different across states in India. The exercise undertaken at the National Institute of Public Finance and Policy (NIPFP) suggests that even if the tax net is expanded to include financial services and local sales of computer-related services, the present classification of goods is retained with the proposed rates of 6 per cent for basic goods and 8 per cent for services, at least four states would require standard rates higher than 15 per cent for revenue neutrality — Chhattisgarh, Goa, Haryana and Jharkhand. The average rate for all the states is 11.7 per cent. Since financial services are considered difficult to tax and bulk of computer-related services are either inputs or exports, if these two sectors are excluded from the base, the average revenue-neutral rate increases to 14.7 per cent and the number of states requiring standard rate higher than 15 per cent increases to nine, including Bihar, Delhi, Gujarat, Kerala and Punjab. Even if one assumes that the tax base for goods expands by 10 per cent as a result of lower distortions and improved tax compliance in the new regime, there will still remain two states with a revenue neutral rate above 15 per cent, and at least five states with revenue-neutral rates above 12 per cent. These differences in rates arise because some states lose more from central service tax (CST) than they could gain from inclusion of services in the base. This economic reality is not a transition issue but a structural issue. States might find it difficult to accept compensation as the answer to this changed economic reality.
The above suggests that if present revenues are to be considered an indication of the needs of the states, then in order to protect these needs, the states would require different rates of tax under GST. The question then is: Is uniformity essential to the introduction of GST? Would it be essential to bring India together into a common market? That purportedly is the goal of GST. And the answer to that question would be no. GST is meant to be a tax on final consumption. From the decisions so far, GST is structured as a destination-based tax — the design of inter-state GST supports this intention. In the case of a destination-based tax, the rates of tax need not be same across states — since only local sales are subject to the tax, the regime does not discourage inter-state transactions and the integration of India into a common market. In order to prevent rate wars, it would be important and adequate to prescribe a floor rate on both the standard rate and the lower rate of tax. If there exists some state which seeks to raise more revenue, with the associated risk of some trade diversion to neighbouring states, it should have the liberty to do so. Allowing for this option at least in the medium run would allow for compensation to be limited to transitional revenue considerations.
International experience suggests that such regimes are perfectly feasible: Canada and the EU are two significant examples. The harmonised sales tax (HST) regime in Canada now incorporates three rates of tax and so does the EU.
In other words, there is some merit in exploring the option of complete uniformity in rates as well as procedures, however, it may be kept in mind that such uniformity especially in rates is not essential. Uniformity in forms and procedures possibly contributes more to reducing compliance costs that uniformity in rates alone does. In this direction, the announcement of the acceptance of a single information system for return filing for GST is a very welcome measure. It is hoped, that inherent in this measure is the assumption that the GST regime would work with one registration and one return.
