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GST Bill half-passed but FM needs to guard against serious fault lines!

TIOL - COB( WEB) - 447
MAY 07, 2015

By Shailendra Kumar, Editor

IN the history of Indian GST, May 06, 2015 is going to be remembered as the red-letter day irrespective of whether India finally keeps its promise with April 1, 2016 or not. And the credit obviously goes to the Union Finance Minister, Mr Arun Jaitley, and the floor managers of the NDA Government in the Lok Sabha who tried hard to take the detractors in the House into confidence. Mr Jaitley tried everything up his sleeves to woo the Congress Party and once again reiterated that there would be no revenue loss to the States and if there is any eventuality of this nature the Union Government would compensate for the same. The Finance Minister went to the extent of assuring that there would be no cascading effect of 1% additional tax on inter-state trade of goods. Whether his pleas and promises would really command the ears and the hearts of the Opposition Parties in the Rajya Sabha where the Opposition has the majority, only time can tell but for the FM, the first round of serious battle is indeed half-won.

Let's now examine the two-fold, rather three-fold promises the Finance Minister made in the House, including that of the lower than 27% GST rate as suggested by the Empowered Committee of State Finance Ministers. Let's start with his Promise No 1. When he says that no State would suffer from revenue loss he is correct to the two decimal point if one goes by the most bizarre GST rate of 27% - nowhere in the world such a high rate prevails. Even if one comes across a couple of GST economies with more than 20% tax rate that is obviously because of the guaranteed social spending behaviour of the economy. The countries where social security network is deeper and wider, have all the valid reasons to opt for higher GST. But, such a rationale is out of place for a country like India where social spending is politics-driven and also a fashion statement which is often made by contesting political parties generally before the polls. Leave aside education, health, shelter, power, road and other basic needs, even potable water falls in the category of luxury items for a good swathe of Indian population.

In this background of minimal optional constitutional commitment, a GST rate of 27% can certainly be interpreted as a more than promising tax rate to guarantee no revenue loss to the States. But what obviously does not get guaranteed in this scenario is the economic welfare of the common citizens. Given the global reality and the inherent demerit of the indirect taxes which fail to positively discriminate like the direct taxes between the rich and the poor as the incidence of such taxes hurts the poor the most. And this is what makes it the completely pass-through tax. So, it is very clear with no shades of doubts that with 27% GST rate, the citizens may find their economic welfare running into deficit but the States cannot bemoan for revenue loss as this is obviously one of the certainties guaranteed by such a high rate. Whether the FM would succeed in bargaining it down by one or two per cents with the States, it may not mean much for the taxpayers as it would still prove to be pyrrhic victory for the FM and back-breaking for the common man.

In this context, let me reproduce what I collected from my conversation with the GST Chief of Royal Malaysian Customs, Mr Subromaniam Tholasy, who is in the National Capital to attend the Asia-Pacific Tax Forum (APTF) meet organised by the International Tax & Investment Center (ITIC) headquartered at Washington. Netizens may recall that Malaysia happens to be the latest economy to join the GST bandwagon with 6% GST rate from April 1, 2015. Although I threw a wide range of questions at him but what is pertinent here is the one relating to how Malaysia has been able to cushion the impact of the new tax system on the poor segment of the population. And his answer was - they have gone for Direct Cash Transfer to the identified poor so that they are not hit by the new tax system. This clearly indicates that if India rolls out the new indirect tax system with 25%-27% tax rate, the Union and the State Governments would have to undertake measures to cushion the impact of high tax rate on the poor segment of the society.

Let's now go to the second plank of his promise - no cascading effect of 1% additional tax on inter-state trade of goods. Here it may appear that the Finance Minister has not been advised properly. Or, his battery of GST experts has either not done a proper homework or is not at all familiar with the ground realities of different business models that are operational in the economy. The FM's compulsion to accept such a demand from the industrialised States is understandable. But what is not understandable is the so-called compulsion to introduce distortion in the proposed tax system. To win over some originating or exporting states the FM agreed to their demand but whether it was necessary to incorporate the same in the 122nd Amendment Bill is debatable. It seems no effort was made to look for better options rather than 'polluting' the proposed system. The soul of the new system is to ensure uninterrupted credit flow but the GST Bill states that no credit would be available for this 1% additional tax.

Now the question is - Whether this 1% additional tax is actually going to be just 1% or would get multiplied? If we do a reality check, it may emerge that if a product travels across five depots in five States before being sold to the customer it would carry an effective burden of 5% additional tax. Compared to this trader, a small importer who directly imports the same goods to the State of final consumption would not suffer this tax. This would make the imported goods cheaper than the domestically produced goods. In large integrated manufacturing operations, raw-materials and consumables (technically inputs) travel across depots in many states before being used. The concept of minimum inventory and just-in time has become standard practice for cost minimisation. This healthy inventory management practice would soon come under pressure to be abandoned. In keenness to bring GST, the Union Government seems to have agreed to a tax which would make India a much less competitive manufacturing hub which would in turn hurt the 'Make in India' dream of the Prime Minister. There could have been much simpler ways of addressing the issue of generating some revenue for the originating/exporting state by allowing an extra SGST of 1% to be levied even in case of inter-state sales and then working out a mechanism to lapse the accumulated credit periodically if the seller was not able to utilize it.

Alternatively, distribution of IGST could have been tweaked using a formula negotiated between the States within the GST framework so that some benefit accrued to the exporting state. The idea of 1% tax is entirely unworkable and would only lead to distortions. Further, a lot of inter-state sales would start getting reported as Intra-State sales to save on this additional tax. India is destined to become less competitive compared to the imported goods on this count alone.

To find out a conceptually and also legally much healthier option I interacted with the one of the most respected GST experts globally, Mr Sijbren Cnossen, at the APTF. Mr Cnossen is a Professor at the Economics Faculty of the University of Pretoria, Academic Partner of CPB Netherlands Bureau for Economic Policy Analysis, and Emeritus Professor of Economics at Maastricht University, The Netherlands, and of Tax Law at Erasmus University Rotterdam. He has held appointments at the Law Schools of Harvard University, New York University and the University of Florida, the College of Europe at Bruges, and The Netherlands Institute for Advanced Study. Professor Cnossen has served with the Fiscal Affairs Department of the International Monetary Fund (IMF) and the Dutch Tax Service. Further, he has been a consultant to the Organization for Economic Cooperation and Development (OECD), the European Commission, the IMF, the World Bank, the Harvard Institute for International Development (HIID), and the United States Agency for International Development (USAID). He is a senior economic advisor to the International Tax and Investment Center (ITIC). When I explained to him the economic compulsion of introducing 1% additional tax, his instant reaction was - a highly avoidable distortion. He suggested that if it was a part of the deal with the federating states, the actual solution could have been allowing the States to collect one per cent additional SGST or there could have been a lapsable independent bill to allow the originating states to collect such a tax for the limited period.

Yet another distortion can be found in the Article 366 (clause 29A) relating to Works Contract. Post GST there would be no need to vivisect works contract as both the Centre and the States would be taxing the entire supply of goods and services in case of a composite supply, yet the constitutional provisions which allowed states to collect VAT on goods component of the supply in works-contract is not proposed for deletion (Interestingly, such a deletion was a part of the previous Bill - 115th Constitutional Amendment Bill). The minefield of the litigation of works-contract would continue to be alive even post GST regime for the purposes best known to the babus who worked out the constitutional amendment bill.

There is a simple reason for such serious fault lines in the GST being worked out by the officials under the aegis of Empowered Committee - “capacity deficit“. The leadership of the entire exercise is in the hands of IAS officers who are generalists having no background in taxation. The revenue officials assisting them are aware of the Indian tax laws and practices but do not know the best international practices on various issues which every GST regime has to struggle through. This is leading to a very regressive GST regime being worked out without any consultation with Indian trade and international experts. In fact there is serious effort to keep the details of the work done till date as a secret, completely hidden from the eyes of trade and industry. It is common knowledge that modifications in SAP systems due to GST regime would easily take a year or two. The expected date of implementation of GST is only 11 months away and yet trade and industry is being kept blind. Unfortunately, many of the distortions have been forced by the States ruled by the BJP which only shows that a lot can be improved, if the BJP, as a party, ensured common stand by its Ministers in the States and at the Centre. One expects that the politically astute and mature Finance Minister would see through the turf battles and limited vision of the babus and State Finance Ministers and would rectify the situation before it is too late.

TIOL urges the Finance Minister to initiate trade consultations and hire best international experts for supervision of the process of conceiving and implementing GST as India certainly deserves a better version of GST. If the constitutional amendment bill requires a relook let the Select Committee do it for the better. One should not forget that poor implementation of the controversial GST was a serious electoral issue in Canada in 1991. Even in 2015, it is proving to be a serious headache for the Government of Malaysia. Let's quickly learn from the international experiences and reap the benefits of being one of the last few economies which are going to join the GST bandwagon. After all, joining last has its own benefits and India should not forfeit the same to careless approach and poor planning?