DECEMBER 12, 2018

By Vijay Kumar

GST is certainly not a failure but it could have been more along the lines of what I had initially recommended - Arvind Subramanian.

FORMER Chief Economic Advisor (CEA) Arvind Subramanian, in the course of launching his book "Of Counsel: The challenges of Modi-Jaitley Economy", said that GST is not a failure but could have been better, if the recommendations in his report were followed.

In 2015, a Committee of experts headed by the then CEA, Arvind Subramanian submitted to the Government a Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax.

About his report, he states in his book:

I was advised not to publish it because there was dissent within the committee: in fact, senior officials in the revenue department (other than Dr Hasmukh Adhia) distanced themselves from the report. But I had the conviction that public acceptability would depend not on whether there was unanimity but on the quality of the report, including the recommendations and the underlying analysis. I am glad that I did not let the default bureaucratic position of abundant caution and inertia influence me. It also helped that I had the backing of knowledgeable and committed younger officers of the indirect and direct tax departments (Alok Shukla, Amitabh Kumar and Arbind Modi).

He says his report served two critical purposes:

1.  It helped the government convince the Opposition and the public that GST rates did not have to be as high as was being feared.

The report suggested a revenue neutral rate of about 15.5 per cent, whereas the prevailing view based on work done by one of the think tanks (National Institute of Public Finance and Policy) was around 21-22 per cent. As a result, the report helped forge the political consensus in favour of the GST.

2.  The second purpose of the report was to provide a reference point for the GST rate structure.

The report argued for a three-rate structure. The vast bulk of the goods should be taxed at the standard rate, essentials (food items, for example) at a low rate, and products whose consumption society wanted to discourage (like cigarettes and luxury cars) at a higher rate.

He has two wistful reflections about the past and one anxiety for the future. He wonders whether if there had been more conviction about, and stronger political commitment to, simplicity (say no more than three rates) and lower taxes, the rate structure could have come closer to the one he had proposed. Especially with the Centre having promised compensation to the states, it might have been possible to prevent the 28 per cent rate. Once the principle of simplicity and few rates was replaced in favour of the principle that no new rate could be greater than the old rate, the compensation commitment led the states to start haggling for lower rates but in a somewhat arbitrary fashion. He also wonders whether the implementation of GST was handicapped by being the second shock (after demonetization) that had to be imposed on the system, especially on small traders in the informal sector.

His anxiety: the GST has been and seen cooperative federalism at its magnificent best. Yet, as with all things political, equilibriums can be fragile. Chafing at the inability to respond to some local concern, states may start 'defecting'; granting a GST exemption here, raising a rate there, imposing a cess elsewhere. Especially if the political constellation changes, with the Centre unable to nip these defections in the bud, we could get a proliferation of small defections that cumulate over time and eat into the integrity of the GST as one country, one market, one tax. He fervently prays this will not happen.

According to the former CEA, three major benefits will flow from the GST.

-  First, it will increase the resources available for poverty alleviation and development. This will happen indirectly as the tax base becomes more buoyant and as the overall resources of the central and state governments increase. But it will also happen directly because the resources of the poorest states-for example, Uttar Pradesh, Bihar and Madhya Pradesh-who happen to be large consumers, will increase substantially.

-  Second, the GST will facilitate 'Make in India' by essentially establishing 'one India'. The current tax structure unmakes India by fragmenting the markets along state lines.

-  Third, the GST will improve, even substantially, tax governance in two ways. The first relates to the self-policing incentive inherent in a valued-added tax. To claim input tax credit, each dealer has an incentive to request documentation from the dealer behind him in the value-added tax chain. Provided the chain is not broken through wide-ranging exemptions, especially on intermediate goods, this self-policing feature can work very powerfully in the GST system. The second improvement in tax governance relates to the dual monitoring structure of the GST-one by the states and one by the Centre. Critics and taxpayers have viewed the dual structure with some anxiety, fearing two sources of interface with the tax department and, hence, two potential sources of harassment. But dual monitoring should also be viewed as creating desirable tax competition and cooperation between state and central authorities.

Of course, these benefits will only flow through a well-designed GST system. And what is that? Mr. Subramanian comments:

-  The GST should aim at tax rates that protect revenue, simplify administration, encourage compliance, avoid adding to inflationary pressures and keep India in the range of countries with reasonable levels of indirect taxes.

-  To this end, the report recommended a revenue neutral rate between 15 and 15.5 per cent and a standard rate of about 18 per cent. The report also urged that the GST be comprehensive in its coverage, that exemptions from the GST be limited to a few commodities that catered to clear social benefits, and that most commodities be taxed at the standard rate.

-  There is no free lunch here. There is no escaping the fact that more the exemptions or exclusions, the higher will be the standard rate which could affect poorer consumers.

-  Some have levelled the charge that the inherent design of the GST system is flawed. Clearly, the current design is not ideal and could be improved. But the 'flawed GST' charge fails to appreciate how reforms actually occur. In no country is the GST-even today after many years of implementation-perfect, and was therefore quite flawed at inception.

-  In complex systems, change is introduced and then learning from implementation takes place, leading to further and better change. That is what happened with the implementation of the VAT by the states. Such complexity and lags in GST implementation require that any evaluation of the GST, and any consequential decisions, should not be undertaken over short horizons.

-  Facilitating easy implementation and taxpayer compliance at an early stage-via low rates and without adding to inflationary pressures-will be critical. In the early stages, if that requires countenancing a slightly higher fiscal deficit, that would be worth considering as an investment which would deliver substantial long-run benefits.

-  In understanding GST systems around the world, we have been struck by how ambitious and how under-flawed the Indian GST is in comparison. GST-type taxes in large federal systems are either overly centralized, depriving the sub-federal levels of fiscal autonomy (as in the case of Australia, Germany and Austria); or where there is a dual structure, they are either administered independently creating too many differences in tax bases and rates that weaken compliance and make interstate transactions difficult to tax (as in the case of Brazil, Russia and Argentina); or administered with a modicum of coordination which minimizes these disadvantages (as in the case of Canada and India today) but does not do away with them.

-  The Indian GST will be a leap forward in creating a much cleaner dual VAT, which would minimize the disadvantages of completely independent and completely centralized systems. A common base and common rates (across goods and services) and across states and the Centre will facilitate administration and improve compliance while also rendering manageable the collection of taxes on interstate sales. At the same time, the exceptions-in the form of permissible additional excise taxes on sin goods (petroleum and tobacco for the Centre, petroleum and alcohol for the states)-will provide the requisite fiscal autonomy to the states. Indeed, even if they are brought within the scope of the GST, the states will retain autonomy in being able to levy top-up taxes on these 'sin/demerit' goods. To have achieved this, in a large and complex federal system of multi-party democracy, with a Centre, twenty-nine states of widely divergent interests via a constitutional amendment requiring broad political consensus, affecting potentially 2-2.5 million tax entities, and marshalling the latest technology to use and improve tax implementation capability, is perhaps breathtakingly unprecedented in modern global tax history.

-  Sometimes we are insufficiently appreciative of how much the country has achieved in coming to this point with the GST. Credit should go to all political parties at the Centre and the states for having worked towards, even if all of them have also occasionally worked against, the GST. The time is ripe to collectively seize this historic opportunity; not just because the GST will decisively alter the Indian economy for the better but also because the GST symbolizes Indian politics and democracy at its cooperative, consensual best.

The former CEA recalls, "Perhaps the high point of democratic decision making occurred when Dr Issac (politically opposed to the government on a number of policies, including demonetization) politely asked to walk out of the meeting because he could not go along with the emerging consensus on taxation of gambling. Jaitley went out of his way to cajole him back and accommodate his views, all the while ensuring that the delicate consensus amongst the other twenty-eight ministers was not ruptured."

But was GST an issue in the recent elections?