India’s Goods and Services Tax Bill – A Critical Evaluation

  • July 26, 2016

The original blueprint of the Goods and Services Tax (GST) bill was first introduced in 2001. It aims to adopt a value added tax (VAT) model, and replace the current national-level central excise duty and state-level sales tax model. Heated debates in parliament has hindered the passage of the bill, which has been modified several times.

India’s current tax system is complex and multi-layered. Cross-border compliance, compounding of taxes on domestically produced goods and services, in addition to several central and state taxes, exacerbate the complexity of the system. This is why the government has realized the need for an efficient, transparent, and simple method of indirect taxation in the form of the GST bill. The bill indicates that the GST will be a tax on the final consumption or the actual supply of goods and services. The basic provision of the tax is that economic activity at each stage of production is taxed at the same rate, preventing further fragmentation. The GST will comprise of three main taxes: CGST (Central), SGST (State), and IGST (Inter-State). This article critically evaluates the bill. The first section looks at the benefits of the GST, the second section addresses the drawbacks of the GST, and the final section looks at how the GST will affect the landscape of the Indian economy.

Beneficial features

  • The GST subsumes all other indirect taxes, including central excise, service tax, countervailing duty, special additional duty, octroi, CST (Central Sales Tax), and VAT (Value added Tax). Consequently, the GST facilitates the creation of a single tax reporting structure. The setting up of an all-encompassing tax will finally push India one step closer to becoming a unified market. Currently, states vastly differ in taxation compliance, making intra-state and inter-state trade cumbersome. The introduction of the GST will reduce the economic distortions caused by inter-state variations in taxes.
  • It will broaden the tax base. The concept of Value Added Tax (VAT) was introduced for central excise duty in 1986. Prior to this, excise duty was levied on both inputs used and the output produced. This meant that an amount paid as tax on the input was subject to taxation again at the output level (with limited set offs). This was applicable to each intermediate good in the manufacturing process. A similar cascading of taxes will take place under the GST regime. However, different stages of production will not be taxed at different rates. Subsequently, one stage of production is not favored over the other, and will further prevent corruption in the supply chain.
  • Another degree of unnecessary complexity has been removed by avoiding the differentiation between a good or service, whether as an input or as a finished product. Under the GST, tax paid on inputs is deducted from the tax payable on the output produced. The tax is collected only at the place of consumption. This design addresses the cascading of taxes and emphasizes on how no goods or service is exempt from the tax. This mechanism also encourages voluntary compliance. A person in the supply chain gets credit only when the previous person pays tax. Currently, goods are taxed comparatively heavier than services, while some services are not taxed at all. This directly causes a structural bias against the manufacturing industry, and creates several complications.
  • Production costs will be significantly reduced, allowing more space for greater productivity, innovation, and creating exports that are more competitive. It will reduce the bureaucratic bottlenecks by reducing the interaction points with several government agencies and will lessen the associated paperwork. The GST is also forecast to increase tax revenue for the government, while simultaneously decreasing the tax burden on the final consumer. Statistical estimates show that at least a 1 to 3 percent increase in the Gross Domestic Product (GDP) originates from cost-cutting. The GST and associated cost savings will boost investment in machinery, build process capability, and increase consumption, all of which will feed back positively into the economy.

Drawbacks

  • Some electricity and petroleum products are exempt from the GST for at least a few years, from when the tax is introduced. The products include petroleum crude, high-speed diesel, motor spirit (petrol), natural gas, and aviation turbine fuel. Separately, natural gas, real estate, and alcohol are also exempt. The exemptions defeat the purpose of the bill’s primary objectives, which allow for discrimination of some supplied goods and services. Since a good like petroleum feeds into other industries, exemptions for such goods will also lead to a revenue loss for the government.
  • A few states such as Punjab, have expressed their preference for taxing specific goods separately. The central government has granted some tax exceptions in certain cases. Such exceptions dilute the applicability of the law. Instead of granting such exemptions, a possible alternative would be for the central government to compensate state governments for the revenue shortfall that the GST may entail.
  • The Bill states that the central government may levy an additional tax of up to 1 percent on the supply of goods in the course of inter-state trade for two years or longer. This tax will be collected by the central government and will accrue directly to the states from where the supply of the good originates. The levy of the additional tax distorts the creation of a national market, as a product made in one state and sold in another would be more expensive than one made and sold within the same state. Cascading of taxes will be magnified if the production and distribution chain passes through several states. In addition, the eventual burden will be borne by the final consumer of the product, thus creating a disproportionate tax spread.

Observations

The government’s attempt to implement the GST bill is noble as it aims to reduce the complexity in India’s existent tax regime. The passage of the bill can abolish unnecessary complications by creating a well-defined and uniform tax regime. However, the government faces many obstacles. It first needs to clear political roadblocks, as the bill seeks passage from both the houses of parliament in India to become a law. Secondly, it needs to alter the bill’s structure in a manner that is acceptable to all states. Finally, the bill needs smooth implementation, which can only be assured if companies and citizens are educated about the nuances of the bill. If the government is able to overcome these roadblocks, it will help to create a conducive tax environment in India that boosts business and helps the overall economy.

This article was first published July 2016.
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