INDIA
23 July 2015
Rationale & Key Requirements For Implementing GST In Indian States
Mukul Asher shares his views on the rationale and key requirements for implementing GST in Indian states.
The time has come to align tax administration in the States with the aspirations of the citizen for a modern, and technologically enabled, and service-oriented tax administration. What are the key requirements and focus areas for an effective roll-out of the GST?
The GST (Goods and Service Tax) Constitutional Amendment Bill (representing 122nd such amendment) was passed by the Lok Sabha on May 6, 2015. It permits the Union government to levy sales tax on goods, and States to levy sales tax on services, both barred in the original constitution.
The GST, when ultimately implemented (as of end June 2015, the Bill is still awaiting passage by the Rajya Sabha, but the official target is to implement GST by April 1, 2016), will facilitate a coherent and unified approach to taxing goods and services by both the Union and the State governments for the first time since independence.
While India became a politically unified country in 1947, inappropriate and counterproductive economic policies, exhibiting insufficient understanding of how a combination of market and government can address India’s public policy and development challenges, led overtime to a severe fragmentation of India’s domestic market. As a result, the country has had to bear huge costs in terms of much lower quality of life, significant constraining of economic and social opportunities, and reduced resilience of the economy and society. It has also adversely impacted India’s competitiveness, generation of productive livelihoods, and inflation management.
Low level of economic literacy exhibited by large section of the policymakers, political class, media, and others is also continuing to adversely impact India’s rapid progress from a low-middle income country to a high-middle income country.
The GST Bill, along with complementary reforms is focusing on reducing cost of doing business, and creation of new enterprises, particularly small and medium enterprises (SMEs), expected to facilitate India’s emergence as a single market, an outcome which is long overdue.
A single unified national market has the potential to significantly reduce logistics, supply chain and other transaction costs to businesses; compliance costs for the taxpayers, and potentially improve tax administration, while enhancing prospects for better realization of economies of scale and scope in production and distribution activities.
Without rapidly progressing towards a single market, India’s prospects for emerging as a major economic power with commensurate economic and strategic space globally would be severely undermined. Therefore impediments put in the GST implementation do not serve the nation’s strategic interest, and must be portrayed in the media and perceived by the electorate in this manner.
The GST in India will be implemented under a dual rate structure (GST at the Union Government, and GST at the State level, with some interim arrangements for inter- state transactions, which it is hoped will be eliminated over time).
There is no prior experience globally of a federal country (29 states, 7 union Territories), with a population of 1.25 billion implementing such an ambitious tax reform. So India needs to device its own context-specific solutions in designing and implementing GST. This is an added reason for exhibiting responsibility and seriousness of purpose, as well in ensuring careful preparations in implementing GST by all the Stakeholders.
The relevant data are obtained from the Indian Public Finance Statistics and the Hand book of Statistics on India’s Economy of the Reserve Bank of India
On the basis of the 2013-14 composition of combined Union and State government expenditure and taxes, the following observations may be made.
The combined expenditure and tax revenue to GDP ratios were 28.2 percent and 17.9 percent of GDP respectively, while the combined operating revenue to GDP ratio was 20.4 percent of GDP.
The key economic question arising from these ratios are the following. First, is the quality and quantity of public services and amenities, and of governance commensurate with the government sector transferring resources from the Indian citizen’s equivalent to nearly 30 percent of India’s GDP?
Broad consensus is likely to be that they are not, and therefore the focus should be on how to improve the outcomes from government spending rather than relying on higher and higher outlays. This does not prevent reallocation of existing outlays among different uses.
While detailed balance sheet data of the Union and State government are not available, a case can be made that the government entities also disproportionately use nation’s and therefore Indian citizen’s assets (e.g. land mining ,wealth, air space and other property rights etc), without sufficient commensurate benefits. Economic and societal value generated from these assets has been low. Potential for generating such value is illustrated from the revenue generation equivalent to 2.5 percent of GDP from coal mining auctions of some of the mines which has so far been undertaken. India needs to develop competence in using balance sheet of the government to generate revenue rather than relying on income flows alone.
Taxes are financing less than two-third of total expenditure, corresponding ratio for the operating revenue being 72 percent. There is therefore scope for improving revenue performance, but by broadening tax bases and more rational use of cost recovery and user charges, rather than through including through tax rate increases inappropriate use of various causes and through use of monopoly pricing by government.
Taxes on Income generated revenue equivalent to 5.7 percent of GDP (with corporate income tax contributing nearly two-third, implying rather narrow individual income tax base); customs duties were 1.6 percent of GDP (this share is unlikely to increase significantly due to many Preferential Trade Agreement, PTAs, which India has entered into), while excise, service tax, and state sales tax combined generated 8.6 percent of GDP. States generated additional 0.7% of GDP from taxes on goods, passenger’s entertainment tax and other taxes and levies.
The above are taxes which are deposited with the government. However, it is essential that the term “taxes” should henceforth be used analytically, as meaning “all compulsory transfer of recourses, including money, from citizen and businesses to government functionaries, even when such transfers do not reach government treasury. When measured appropriately, India’s tax burden is much higher than reported. This is an area meriting empirical research on a disaggregated basis, by location, activity, type of compulsory transfer generated, etc..
The Services Tax generated 1.6 percent of GDP while services share in GDP is around 55 percent. In contrast, the tax generated from goods (sales and excise taxes) at 7 percent of GDP is disproportionate to the share of manufacturing in GDP of less than one-fifth.
As the share of household income spent on service increases with income, the current tax composition is inherently regressive, one of the unfortunate legacies of insufficient emphasis on rigorous economic reasoning in formulating Public Policies.
When goods and services are taxed separately, some at the Union government level, some at the level of States, and inter-state transactions taxes separately, the effective tax rate, as measured by the tax burden to retail price ratio, and by distribution of tax burden between consumers and producers are likely to exhibit large variability. This affects both efficient resource allocation and fairness of the tax system. Moreover each state levying its own sales and other taxes (such as entry tax, and excises) increases businesses and compliance costs, and more pertinently discourages formation of small and medium enterprises. Their importance in generating, income and employment should not be underestimated.
If competently and coherently designed and implemented, the GST is expected to significantly, but not fully, address severity of the above constraints. Some of the reported design of GST design provisions (such as not including petroleum and alcohol in the GST), and continuing tax on intra-state trade, are however likely to prevent realization of full benefits. But a more appropriate stage to analyze these aspects would be when the final decisions on GST design, including tax rate, tax base, and the various Union and State taxes subsumed under it, and operational details, are finalized.
Implementation of GST thus will be a good step forward. A mind-set that recognizes that “let the best not be the enemy of the good” is needed in taking the GST initiative forward.
International experience suggests that in 2014, standard rate of Value Added Tax (VAT), equivalent to the proposed GST in India, was 19.1 percent in OECD (Organization for Economic Cooperation and Development), and 21.7 percent in the European Union countries. In Asian members of the OECD, such as Japan (8 percent), and Korea (10 Percent), the VAT rates are much lower. The revenue from VAT to GDP ratio in OECD averaged 6.6 percent of GDP in 2012. These comparative figures are relevant as India competes with these countries.
The current tax composition has become even more untenable as India’s economy and therefore tax revenue increases. In 2013-14, India’s GDP at market prices was INR 114 trillion. If India’s nominal GDP manages to grow at an annual rate of 12 percent, in six years (by 2019-20), India’s GDP will be INR 228 trillion by 2025-26. Even if the current revenue to sales, services, and excise taxes at 8.6 percent of GDP is maintained, this will generate INR 48 trillion from GST (and excises outside GST) alone.
The current sales and excise administration at the Union and in the States government level will need to undergo a qualitative transformation to effectively implement the GST.
The process of such a transformation can begin even as the design details, (tax rate and tax base definitions, and tax to be subsumed under GST registration requirements for GST etc.) are being worked out. International experience suggests that about fifteen to eighteen months are needed to prepare for implementing a GST type of tax even in countries with a reasonable level of tax administration expertise and use of technology. In many States in India, these requirements are insufficiently met. Thus, in several States computerization and IT infrastructure for sales tax administration is at a very early stage. This lands even greater urgency to begin the process of preparing for GST implementation.
The following represent key areas where the States are urged to focus as they prepare for the GST.
1. IT Infrastructure and Computerization
The States need to strengthen their IT infrastructure and computerization readiness for administering sales, excise, and related taxes. States which give insufficient emphasis to this aspect will find generating realizable revenue from GST difficult, and in an era of co-operative but competitive federalism, will find erosion in their competitiveness in retaining and attracting new business.
As GST implies a shift from Sales tax on the basis of “origin” (where consumption occurs), the States with relatively strong “origin” of production (such as Haryana, Tamil Nadu, Maharashtra, and Gujarat) would need to particularly focus on their IT infrastructure readiness.
2. Initiate Preparation of Service Tax Registry at State Levels
GST will be levied on both goods and services. States do have experience on levying taxes on goods, but not on services. So it is essential that process is begun to build a registry of service tax payers.
The current practice by the CBEC (Central Board of Excise and Customs) is to organize services tax data of the union Government by Commissioners and Chief Commissioners in each state.
The first step in initiating service tax registry at the individual state level is to make the relevant data available to each State. This will be a good starting point for the States. Each State can further refine the service tax registry.
Transaction costs of this exercise can be minimized if the proposed GST council takes the initiative for such transfer of information from the Union to the individual State governments
The individual governments could also take initiative to familiarize their tax officials about the operational requirements of the services tax. Such knowledge-transfer with the different levels of governments is vital as effective implementation of GST requires it.
3. Explore How Best to Use GSTN(Goods and Services Tax Network)
The Union government has set up GSTN as a statutory company to create a common IT infrastructure to serve the needs of various stakeholders, including the individual States. Registration, Returns, and Challans (Payment instruments) represent three of the critical work processes of the GST.
The individual States could consider exploring with GSTN how its services could be best utilized by the concerned State to facilitation transition from the current VAT to GST. Capacity building component for this area can also be considered to facilitate GST implementation. GSTN requires considerable capital expenditure and investment in technical and professional expertise which individual States can utilize.
Finally, individual States need to review their human resource policies and practices for tax administration. Transition to and subsequent implementation of GST will require different and higher levels of skill-sets than what is currently exhibited by almost all States.
In this area as well, States could consider co-operating with Union government, through its agencies, to developing requisite human resources, and skill-sets.
Focusing on the above four areas to prepare for GST implementation would make genuine interests and needs of the Union government, States, taxpayers, administration and other stakeholders more compatible with nation’s interests. Those benefiting from current inefficient, insufficient transparent and accountable tax administration may resist the needed reforms. But their short-term interest should no longer be permitted to detract from the overall public and national interest.
There is considerable merit in individual States viewing transition to and implementation of GST as a high priority project, with clear demarcation of benchmarks to be achieved and setting of accountability for the outcomes.
The time has come to align tax administration in the States with the aspirations of the citizen for a modern, and technologically enabled, and service-oriented tax administration.
The GST (Goods and Service Tax) Constitutional Amendment Bill (representing 122nd such amendment) was passed by the Lok Sabha on May 6, 2015. It permits the Union government to levy sales tax on goods, and States to levy sales tax on services, both barred in the original constitution.
The GST, when ultimately implemented (as of end June 2015, the Bill is still awaiting passage by the Rajya Sabha, but the official target is to implement GST by April 1, 2016), will facilitate a coherent and unified approach to taxing goods and services by both the Union and the State governments for the first time since independence.
While India became a politically unified country in 1947, inappropriate and counterproductive economic policies, exhibiting insufficient understanding of how a combination of market and government can address India’s public policy and development challenges, led overtime to a severe fragmentation of India’s domestic market. As a result, the country has had to bear huge costs in terms of much lower quality of life, significant constraining of economic and social opportunities, and reduced resilience of the economy and society. It has also adversely impacted India’s competitiveness, generation of productive livelihoods, and inflation management.
Low level of economic literacy exhibited by large section of the policymakers, political class, media, and others is also continuing to adversely impact India’s rapid progress from a low-middle income country to a high-middle income country.
The GST Bill, along with complementary reforms is focusing on reducing cost of doing business, and creation of new enterprises, particularly small and medium enterprises (SMEs), expected to facilitate India’s emergence as a single market, an outcome which is long overdue.
A single unified national market has the potential to significantly reduce logistics, supply chain and other transaction costs to businesses; compliance costs for the taxpayers, and potentially improve tax administration, while enhancing prospects for better realization of economies of scale and scope in production and distribution activities.
Without rapidly progressing towards a single market, India’s prospects for emerging as a major economic power with commensurate economic and strategic space globally would be severely undermined. Therefore impediments put in the GST implementation do not serve the nation’s strategic interest, and must be portrayed in the media and perceived by the electorate in this manner.
The GST in India will be implemented under a dual rate structure (GST at the Union Government, and GST at the State level, with some interim arrangements for inter- state transactions, which it is hoped will be eliminated over time).
There is no prior experience globally of a federal country (29 states, 7 union Territories), with a population of 1.25 billion implementing such an ambitious tax reform. So India needs to device its own context-specific solutions in designing and implementing GST. This is an added reason for exhibiting responsibility and seriousness of purpose, as well in ensuring careful preparations in implementing GST by all the Stakeholders.
Combined Union and State Expenditure and Tax Composition and Its Implications
This section provides a brief overview of aggregative data on India’s expenditure and tax composition for Union and State governments combined for the year 2013-14. All data are actual nominal amounts officially recorded.The relevant data are obtained from the Indian Public Finance Statistics and the Hand book of Statistics on India’s Economy of the Reserve Bank of India
On the basis of the 2013-14 composition of combined Union and State government expenditure and taxes, the following observations may be made.
The combined expenditure and tax revenue to GDP ratios were 28.2 percent and 17.9 percent of GDP respectively, while the combined operating revenue to GDP ratio was 20.4 percent of GDP.
The key economic question arising from these ratios are the following. First, is the quality and quantity of public services and amenities, and of governance commensurate with the government sector transferring resources from the Indian citizen’s equivalent to nearly 30 percent of India’s GDP?
Broad consensus is likely to be that they are not, and therefore the focus should be on how to improve the outcomes from government spending rather than relying on higher and higher outlays. This does not prevent reallocation of existing outlays among different uses.
While detailed balance sheet data of the Union and State government are not available, a case can be made that the government entities also disproportionately use nation’s and therefore Indian citizen’s assets (e.g. land mining ,wealth, air space and other property rights etc), without sufficient commensurate benefits. Economic and societal value generated from these assets has been low. Potential for generating such value is illustrated from the revenue generation equivalent to 2.5 percent of GDP from coal mining auctions of some of the mines which has so far been undertaken. India needs to develop competence in using balance sheet of the government to generate revenue rather than relying on income flows alone.
Taxes are financing less than two-third of total expenditure, corresponding ratio for the operating revenue being 72 percent. There is therefore scope for improving revenue performance, but by broadening tax bases and more rational use of cost recovery and user charges, rather than through including through tax rate increases inappropriate use of various causes and through use of monopoly pricing by government.
Taxes on Income generated revenue equivalent to 5.7 percent of GDP (with corporate income tax contributing nearly two-third, implying rather narrow individual income tax base); customs duties were 1.6 percent of GDP (this share is unlikely to increase significantly due to many Preferential Trade Agreement, PTAs, which India has entered into), while excise, service tax, and state sales tax combined generated 8.6 percent of GDP. States generated additional 0.7% of GDP from taxes on goods, passenger’s entertainment tax and other taxes and levies.
The above are taxes which are deposited with the government. However, it is essential that the term “taxes” should henceforth be used analytically, as meaning “all compulsory transfer of recourses, including money, from citizen and businesses to government functionaries, even when such transfers do not reach government treasury. When measured appropriately, India’s tax burden is much higher than reported. This is an area meriting empirical research on a disaggregated basis, by location, activity, type of compulsory transfer generated, etc..
The Services Tax generated 1.6 percent of GDP while services share in GDP is around 55 percent. In contrast, the tax generated from goods (sales and excise taxes) at 7 percent of GDP is disproportionate to the share of manufacturing in GDP of less than one-fifth.
As the share of household income spent on service increases with income, the current tax composition is inherently regressive, one of the unfortunate legacies of insufficient emphasis on rigorous economic reasoning in formulating Public Policies.
When goods and services are taxed separately, some at the Union government level, some at the level of States, and inter-state transactions taxes separately, the effective tax rate, as measured by the tax burden to retail price ratio, and by distribution of tax burden between consumers and producers are likely to exhibit large variability. This affects both efficient resource allocation and fairness of the tax system. Moreover each state levying its own sales and other taxes (such as entry tax, and excises) increases businesses and compliance costs, and more pertinently discourages formation of small and medium enterprises. Their importance in generating, income and employment should not be underestimated.
If competently and coherently designed and implemented, the GST is expected to significantly, but not fully, address severity of the above constraints. Some of the reported design of GST design provisions (such as not including petroleum and alcohol in the GST), and continuing tax on intra-state trade, are however likely to prevent realization of full benefits. But a more appropriate stage to analyze these aspects would be when the final decisions on GST design, including tax rate, tax base, and the various Union and State taxes subsumed under it, and operational details, are finalized.
Implementation of GST thus will be a good step forward. A mind-set that recognizes that “let the best not be the enemy of the good” is needed in taking the GST initiative forward.
International experience suggests that in 2014, standard rate of Value Added Tax (VAT), equivalent to the proposed GST in India, was 19.1 percent in OECD (Organization for Economic Cooperation and Development), and 21.7 percent in the European Union countries. In Asian members of the OECD, such as Japan (8 percent), and Korea (10 Percent), the VAT rates are much lower. The revenue from VAT to GDP ratio in OECD averaged 6.6 percent of GDP in 2012. These comparative figures are relevant as India competes with these countries.
Requirements for Effective GST Implementation in the Indian States:
A major area which could prevent fuller realization of GST benefits is inadequate planning and preparation. It is this aspect, particularly concerning the States, that is discussed in this sectionThe current tax composition has become even more untenable as India’s economy and therefore tax revenue increases. In 2013-14, India’s GDP at market prices was INR 114 trillion. If India’s nominal GDP manages to grow at an annual rate of 12 percent, in six years (by 2019-20), India’s GDP will be INR 228 trillion by 2025-26. Even if the current revenue to sales, services, and excise taxes at 8.6 percent of GDP is maintained, this will generate INR 48 trillion from GST (and excises outside GST) alone.
The current sales and excise administration at the Union and in the States government level will need to undergo a qualitative transformation to effectively implement the GST.
The process of such a transformation can begin even as the design details, (tax rate and tax base definitions, and tax to be subsumed under GST registration requirements for GST etc.) are being worked out. International experience suggests that about fifteen to eighteen months are needed to prepare for implementing a GST type of tax even in countries with a reasonable level of tax administration expertise and use of technology. In many States in India, these requirements are insufficiently met. Thus, in several States computerization and IT infrastructure for sales tax administration is at a very early stage. This lands even greater urgency to begin the process of preparing for GST implementation.
The following represent key areas where the States are urged to focus as they prepare for the GST.
1. IT Infrastructure and Computerization
The States need to strengthen their IT infrastructure and computerization readiness for administering sales, excise, and related taxes. States which give insufficient emphasis to this aspect will find generating realizable revenue from GST difficult, and in an era of co-operative but competitive federalism, will find erosion in their competitiveness in retaining and attracting new business.
As GST implies a shift from Sales tax on the basis of “origin” (where consumption occurs), the States with relatively strong “origin” of production (such as Haryana, Tamil Nadu, Maharashtra, and Gujarat) would need to particularly focus on their IT infrastructure readiness.
2. Initiate Preparation of Service Tax Registry at State Levels
GST will be levied on both goods and services. States do have experience on levying taxes on goods, but not on services. So it is essential that process is begun to build a registry of service tax payers.
The current practice by the CBEC (Central Board of Excise and Customs) is to organize services tax data of the union Government by Commissioners and Chief Commissioners in each state.
The first step in initiating service tax registry at the individual state level is to make the relevant data available to each State. This will be a good starting point for the States. Each State can further refine the service tax registry.
Transaction costs of this exercise can be minimized if the proposed GST council takes the initiative for such transfer of information from the Union to the individual State governments
The individual governments could also take initiative to familiarize their tax officials about the operational requirements of the services tax. Such knowledge-transfer with the different levels of governments is vital as effective implementation of GST requires it.
3. Explore How Best to Use GSTN(Goods and Services Tax Network)
The Union government has set up GSTN as a statutory company to create a common IT infrastructure to serve the needs of various stakeholders, including the individual States. Registration, Returns, and Challans (Payment instruments) represent three of the critical work processes of the GST.
The individual States could consider exploring with GSTN how its services could be best utilized by the concerned State to facilitation transition from the current VAT to GST. Capacity building component for this area can also be considered to facilitate GST implementation. GSTN requires considerable capital expenditure and investment in technical and professional expertise which individual States can utilize.
Finally, individual States need to review their human resource policies and practices for tax administration. Transition to and subsequent implementation of GST will require different and higher levels of skill-sets than what is currently exhibited by almost all States.
In this area as well, States could consider co-operating with Union government, through its agencies, to developing requisite human resources, and skill-sets.
Focusing on the above four areas to prepare for GST implementation would make genuine interests and needs of the Union government, States, taxpayers, administration and other stakeholders more compatible with nation’s interests. Those benefiting from current inefficient, insufficient transparent and accountable tax administration may resist the needed reforms. But their short-term interest should no longer be permitted to detract from the overall public and national interest.
There is considerable merit in individual States viewing transition to and implementation of GST as a high priority project, with clear demarcation of benchmarks to be achieved and setting of accountability for the outcomes.
The time has come to align tax administration in the States with the aspirations of the citizen for a modern, and technologically enabled, and service-oriented tax administration.