onflicting demands of different stakeholders make tax reform the art of the impossible. While the gainers are silent, the vociferous cacophony of the opponents drowns the voice asking for bold and imaginative reform. It therefore comes as no surprise that the Union finance minister has had to abandon most essential features of the transformational goods and services tax (GST) reform. Bound by the constraint of his 30 colleagues in the GST Council wedded to the legacy system, he is forced to follow the path of mediocrity.
The unanimous passage of the Constitution Bill in Parliament had revived the hopes that Prime Minister Narendra Modi could well make impossible possible and deliver a GST that met the triple objectives of fairness, simplicity, and economic growth. However, the proposals of the GST Council meet none of these objectives.
The positive impact of GST on economic growth will be a result of the removal of cascading of taxes, i.e., noncreditable taxes on investment and production inputs. No credits are allowed for input taxes where the sectors are exempt from tax. The blocked credits add to the cost of investment, and hinder economic growth.
Following the methodology adopted by the GST Council for revenue and inflation impact analysis, we estimate the quantum of cascading taxes to be ~3.2 lakh crore (or 36 per cent of the ~8.8 lakh crore of revenues in 2015-16 to be subsumed under GST) under the current system.
With 50 per cent of the consumption basket remaining exempt from tax under the GST Council proposal, cascading taxes will go up (not down) marginally, to 39 per cent of total revenues. As a result, the positive impact on GDP would be negligible, less than 0.5 per cent.
The objective of simplicity will also remain a mirage if the multi-rate structure and the model GST law are adopted. If anything, complexity may go up during the transition. The model law requirement of state-wise registration will multiply the compliance burden for pan-India service providers by a factor of 30. Despite extensive representations by the industry, the states have refused to adopt a single centralised registration system.
The multi-rate structure will compound the complexity. The impact would be the worst on the SMEs who are illequipped to manage classification of goods in multiple baskets. Kirana store dealer will have goods in all five baskets (exempt, five per cent, 12 per cent, 18 per cent, and 28 per cent). The tax rates will differ for similar products. Bread may be exempt, but other bakery products taxable at a merit rate. What will be the fate of chocolates, biscuits, and fruit bars? The same products bought at a restaurant or fast-food outlet may attract tax at the 18 per cent rate for services. Consumer durables will attract 28 per cent tax when bought, but only 18 per cent when rented as a service. Taxation of mobile phones has already been a matter of controversy. Should they be taxed as telecommunication equipment, cameras, or computers? Fairness is the principal reason for the adoption of the multi-rate structure. Finance Minister Arun Jaitley defends the four-tiered structure by stating that air conditioners and chappals cannot be taxed at the same rate. True, but those with air conditioners also buy chappals .
The benefit to them of a lower rate would, in fact, be substantially more simply because they spend more on them.
The ultimate test of fairness is not the tax rates applicable to individual products, but the overall distribution of the tax burden across lower to upper echelons of society. Surprisingly, the four-tiered structure approved by the GST Council results in a higher tax burden on the bottom 30 per cent of the consumers. EY estimates show that the bottom 30 per cent of consumers accounts for 12 per cent of total consumption spending, but contribute 12.6 per cent to the total taxes on final consumption. Under the fourtiered GST rate structure, their contribution to total taxes goes up to 12.7 per cent.
Viewed from this perspective, the new rate structure worsens the fairness of tax.
This result is not unique to GST reforms in India, but common in most jurisdictions with multi-rate structures. Lower rates for basic necessities do not improve the fairness of tax, and often worsen it. The rich benefit from the lower rates more than the poor simply because they spend more (on items in all rate categories) than the poor.
So, what can be done? The only option to improve the fairness of GST is to replace exemptions and lower rates by a targeted income support program for lower-income consumers. As suggested by Kelkar, Poddar and Bhaskar (in ‘GST: make haste slowly, Mint ,October 19, 2016), this could be in the form of a direct benefit transfer (DBT) of, say, ~2,000 per head per annum for the bottom 27 crore (bottom two deciles of the population). This program would have a cost of ~54,000, which would be a fraction of the cost of exemptions in the GST Council formulation. The GST could then be levied at a single rate of 12 per cent on a broad base, with a supplementary cess on selected demerit and luxury goods. The contribution of the bottom 30 per cent to GST revenues would then fall to 5.4 per cent, from 12.7 per cent under the multirate structure.
The single rate will be pro-poor, bring in simplicity, and spur investment and economic growth.
The GST Council must face up to this reality and decide. It can either sacrifice simplicity and economic growth for all at the altar of keeping a few happy, or take the bold step of adopting an alternative that gives all the three advantages of simplicity, fairness and economic growth.
Satya Poddar is senior advisor, EY. Shalini Mathur is director, tax policy advisory, EY
The unanimous passage of the Constitution Bill in Parliament had revived the hopes that Prime Minister Narendra Modi could well make impossible possible and deliver a GST that met the triple objectives of fairness, simplicity, and economic growth. However, the proposals of the GST Council meet none of these objectives.
The positive impact of GST on economic growth will be a result of the removal of cascading of taxes, i.e., noncreditable taxes on investment and production inputs. No credits are allowed for input taxes where the sectors are exempt from tax. The blocked credits add to the cost of investment, and hinder economic growth.
Following the methodology adopted by the GST Council for revenue and inflation impact analysis, we estimate the quantum of cascading taxes to be ~3.2 lakh crore (or 36 per cent of the ~8.8 lakh crore of revenues in 2015-16 to be subsumed under GST) under the current system.
With 50 per cent of the consumption basket remaining exempt from tax under the GST Council proposal, cascading taxes will go up (not down) marginally, to 39 per cent of total revenues. As a result, the positive impact on GDP would be negligible, less than 0.5 per cent.
The objective of simplicity will also remain a mirage if the multi-rate structure and the model GST law are adopted. If anything, complexity may go up during the transition. The model law requirement of state-wise registration will multiply the compliance burden for pan-India service providers by a factor of 30. Despite extensive representations by the industry, the states have refused to adopt a single centralised registration system.
The multi-rate structure will compound the complexity. The impact would be the worst on the SMEs who are illequipped to manage classification of goods in multiple baskets. Kirana store dealer will have goods in all five baskets (exempt, five per cent, 12 per cent, 18 per cent, and 28 per cent). The tax rates will differ for similar products. Bread may be exempt, but other bakery products taxable at a merit rate. What will be the fate of chocolates, biscuits, and fruit bars? The same products bought at a restaurant or fast-food outlet may attract tax at the 18 per cent rate for services. Consumer durables will attract 28 per cent tax when bought, but only 18 per cent when rented as a service. Taxation of mobile phones has already been a matter of controversy. Should they be taxed as telecommunication equipment, cameras, or computers? Fairness is the principal reason for the adoption of the multi-rate structure. Finance Minister Arun Jaitley defends the four-tiered structure by stating that air conditioners and chappals cannot be taxed at the same rate. True, but those with air conditioners also buy chappals .
The benefit to them of a lower rate would, in fact, be substantially more simply because they spend more on them.
The ultimate test of fairness is not the tax rates applicable to individual products, but the overall distribution of the tax burden across lower to upper echelons of society. Surprisingly, the four-tiered structure approved by the GST Council results in a higher tax burden on the bottom 30 per cent of the consumers. EY estimates show that the bottom 30 per cent of consumers accounts for 12 per cent of total consumption spending, but contribute 12.6 per cent to the total taxes on final consumption. Under the fourtiered GST rate structure, their contribution to total taxes goes up to 12.7 per cent.
Viewed from this perspective, the new rate structure worsens the fairness of tax.
This result is not unique to GST reforms in India, but common in most jurisdictions with multi-rate structures. Lower rates for basic necessities do not improve the fairness of tax, and often worsen it. The rich benefit from the lower rates more than the poor simply because they spend more (on items in all rate categories) than the poor.
So, what can be done? The only option to improve the fairness of GST is to replace exemptions and lower rates by a targeted income support program for lower-income consumers. As suggested by Kelkar, Poddar and Bhaskar (in ‘GST: make haste slowly, Mint ,October 19, 2016), this could be in the form of a direct benefit transfer (DBT) of, say, ~2,000 per head per annum for the bottom 27 crore (bottom two deciles of the population). This program would have a cost of ~54,000, which would be a fraction of the cost of exemptions in the GST Council formulation. The GST could then be levied at a single rate of 12 per cent on a broad base, with a supplementary cess on selected demerit and luxury goods. The contribution of the bottom 30 per cent to GST revenues would then fall to 5.4 per cent, from 12.7 per cent under the multirate structure.
The single rate will be pro-poor, bring in simplicity, and spur investment and economic growth.
The GST Council must face up to this reality and decide. It can either sacrifice simplicity and economic growth for all at the altar of keeping a few happy, or take the bold step of adopting an alternative that gives all the three advantages of simplicity, fairness and economic growth.
Satya Poddar is senior advisor, EY. Shalini Mathur is director, tax policy advisory, EY
The Business Standard New Delhi,07th November 2016
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