India, Single National Market

It needs a central GST to ride on modern information technology system


The most important proposal of the Kelkar Task Force report was a country-wide tax on goods and services (GST) based on the principle of a value added tax (VAT). This tax addresses a series of mistakes in the Indian tax structure today. The present structure holds back India from becoming a single national market, holds back exports of manufacturing and agro-based industries, and holds back cutting customs duties further. Today India has the opportunity of becoming an important player in the global textile industry. This opportunity could be lost if we do not cleanup our indirect tax structure and have zero-rating of exports. China already has a GST which gives its manufacturing an advantage over us.

Effort needs to be on three fronts. First, the BJP needs to give up its partisan attitude and allow BJP ruled states to switch to the state VAT. Jharkhand, the latest state to announce its decision to switch to the State VAT, joined despite being a BJP ruled state, even though the BJP is preventing states from joining the VAT. Hopefully, this indicates a change in the rigid stance of the BJP leadership. Six major states still out of the State VAT are Rajasthan, Chattisgarh, Madhya Pradesh and Gujarat, Tamil Nadu and UP.

The performance of state revenues in the first 5 months of 2005 -- April to August-- has been encouraging. Revenues have grown at 16 percent, higher than the 12 percent historical average. Karnataka, Punjab and Delhi have witnessed even stronger revenue growth at 25 percent. The resistence that was to be expected from traders, who cannot evade taxes as easily under the VAT, has been token. This is partly because of many sensible changes made to the VAT rules that make sure that small traders do not get unneccesarily burdened under the new administration. The self assessment system in the State VAT also reduces the scope for harassment of traders by sales tax officials. But, for the State VAT to work properly, it is important that all states join the VAT. Otherwise, the system provides loopholes to unscrouplous traders to evade taxes.

On it part, the empowered committee needs to address the problems that remain within the state VAT. Other than the need to do away with the Central Sales Tax, which has now been reduced from 4 % to 2 %, and which will go by 2007, another difficulty arises from differences in rates. Different rates on different items make little sense in the framework of the VAT. Input credit given at 4 percent on raw materials is not adequate encouragement to pay 12.5 percent tax. Different rates across states create further distortions. When rates are different across states, it is not difficult to imagine that buyers will move to markets which charge the lowest rate. Often these are just across the border and do not involve any significant transport costs. The states need to realise that while Fiscal Federalism is important, in a globalised economy India has to compete with other countries. Fiscal federalism should be India's strength and not become its weakness. The VAT, in its very design, is not a local tax, any more than the income tax. It will work best if it allowed to function as a national tax. If rates are kept different across states, the VAT will fail to serve India in the efficient and effective manner in which it serves other countries.

The third front which needs to be opened up immediately is at the Centre. The Finance Ministry needs to start preparing for the next stage -- the GST. Given the management difficulties of State VAT, there is a major role for the Centre to provide leadership in showing how a modern GST would work. This is good tax policy for the Centre, which will benefit by having a clean Central GST replacing the malfunctioning Central Excise and Central Service taxes.

An information network allowing states to cross-check payment information (TINXSYS) has been put to trial and is expected to improve compliance and reduce evasion. What is needed is an IT system like the Tax Information Network (TIN), where the TDS or the VAT credit is recorded in a central database. Through this, paper bills and fraud are largely eliminated. It is unfair to expect such an initiative to come from the committee working on State VAT, given the lack of sustained organisational capacity required.

In Budget 2006 the centre must set up an IT intensive Central GST, merging all goods and all services, where all transactions will be recorded in one central database. This IT system should be the centrepiece of how VAT credits and refunds take place, and the treatment of VAT on imports and exports should be completely linked up to the system. While this sounds like a tall order, such a system is a small step away from the existing TIN system and can be implemented given India's IT capacity. The number of establishments involved is smaller than the number of establishments that have already been plugged into TIN. No doubt there would be glitches, as are being experienced under the TIN and the OLTAS, and that is precisely the reason why we need to start sooner rather than later, and why we need to start at a limited level.

The IT based system for the Central GST will be the pilot for the national wide GST. If this is to be done for the Union Budget, the planning for it has to be done now and cannot be left until the budget is presented. It would be ideal to have a single rate such as 12 percent for both goods and service, but that is not a condition for setting up a central GST. The process can begin with the present 16 per cent rate on manufacturing and 10 percent on services, only much better integrated through an IT system that is created with a view to being scaled up to the level of the country.

There is discussion that the GST would require constitutional changes as it proposes that the centre and states both get a share of the tax collected on services. However, the next step in the process, a Central GST riding on a modern IT system requires no such changes and there is no excuse for Finance Minister P Chidambaram to delay implemeting it.


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