The GST of it

Financial Express, 13 June 2009

It has now been some years since the then Finance Minister P Chidambaram had announced that India would implement a full GST from 1 April 2010. Yet, even though we are less than a year away from the date of implementation, there are a number of issues that remain to be solved. These include (i) a consensus on the implementation of the VAT and (ii) the implementation capacity of the government to pull off this very large and complex reform of India's tax system.

The about turn, first by the BJP ruled states, and then by Tamil Nadu, on the GST may add hindrances to the process of consensus building required for implementation of the GST. The GST must be a comprehensive tax with a single rate, if it has to be implemented properly. More than one rate, or providing exemptions to too many products will introduce complexity, create lobbying and increase compliance costs, making the GST another one of those many taxes that people like to evade. One single low rate, lower than rates present today should form the basis of the taxation of all goods and services. By making this into a "pro-poor/anti-poor" issue and politicizing it, the BJP is doing damage to the principles of sound economics that should form the basis of making India a single market and laying the foundations for higher long term growth.

Low rates, accompanied by a central government promise to pay compensation to losing states can make the tax attractive to all states. The rate can be as low as a 7 percent central tax plus a 7 per cent state tax on all goods and services which will be approximately revenue neutral to taxes today. If it is seen that compliance increses, as it is expected to, the tax rate can be reduced further.

The principle of VAT refunds for inputs, whether goods or services, makes a tax like the GST, more attractive in terms of increasing compliance by tax payers. At present, many services are not taxed. The centre announces a list of services which are to be taxed in every budget. Principles of good taxation require that all services should be taxed. The list to be announced should not be the list of services to be included. It should be a small list of services to be excluded. This would mean that other than services on that list, all other services have to be taxed. Today's system in which after the introduction of the service tax, the central government has been adding to the list of services to be taxed, followed by intensive lobbying, needs to be replaced by a system in which based on sound princinple of fairness, equity or extreme difficulties of implementation only some services are excluded. A general goods and services tax can only follow once the centre has formed its own principles of taxation on these sound principles. For this, the centre should introduce a central goods and services tax in the forthcoming budget. This should be based on a single rate for all goods and services. If any exclusions are to be made, it should be done on the basis of "excluded" lists, and not the other way around. If the central government has any intentions of persuading the states to agree to anything like this in less than a years time, it must act immediately.

In this scheme of things, the central government must get rid of all distortionary taxes (such as the STT and the cesses) if it is going to persuade states to get rid of distortionary taxes like stamp duties. The centre must take the leadership in its own hands, set the example, and then persuade states that they must do what is good for the country as a whole. This is necessary to build consensus among states.

Another crucial element of the GST is it implementation. There needs to be an efficient and simple IT system accompanying the GST. To put it simply, this system will take care of refunds paid for GST paid on inputs and will provide the infrastructure for inter state transfers all over the country. Some attempts have been made to set up the implementation of the state VAT in IT system but has not seen to be as successful as hoped. What the GST requires is quite complex and needs to be done efficiently. When the centre announces the union budget it should announce not only a central GST with a single rate and "exempted" lists, it should also start putting in place a bold new system for its implementation. This will lay the foundation for the implementation of a GST in April 2010. And, even if April 2010 turns out to be too close, as it might, it will lay the necessary foundations for it to happen in the following years.

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