Billed as a ‘transformative’ reform of post-independent India, the Goods and Services Tax (GST) has completed three years since it was launched by Prime Minister, Narendra Modi on July 1, 2017. It is time to take stock and see whether there has been any tangible progress in terms of achieving its underlying objectives.
GST is a single nation-wide tax that subsumes within it more than a dozen taxes of the erstwhile dispensation prior to July 1, 2017 viz. central excise duty (CED), service tax, sales tax/value added tax (VAT) besides a host of local taxes such as octroi, purchase tax, turnover tax and so on. At the outset, let us take a look at major anomalies afflicting the old regime.
First, each state government was free to impose as many taxes and fix the rate for each item as it wished. This not only resulted in multiplicity of taxes but also vast variation in the rate for any given tax across states. For instance, natural gas attracts VAT that varies from a low of 5% in Rajasthan, 14.5% in Andhra Pradesh and Karnataka, 15% in Gujarat to a high of 21% in Uttar Pradesh (UP).
This put industries located in high tax states (UP in the above example) to substantial disadvantage vis-à-vis units located in states which charge less say, Rajasthan. It led to an anomalous situation whereby the ability of a business enterprise to compete depended not on its ability to innovate, improve efficiency or cuts costs; instead, it depended mostly on how much taxes it paid. Put simply, it scuttled the incentive and dis-incentive mechanism.
Second, that system was afflicted with what in tax jargon is termed as ‘cascading’ effect. The consumer was forced to pay ‘tax-on-tax’. For instance, in the retail price of petrol in Delhi of about Rs 80 per litre, the taxes account for nearly 2/3rd or Rs 53 per litre. This includes CED: Rs 33/litre and VAT: Rs 20 per litre. The latter includes Rs 9 per litre as VAT on CED or the ‘cascading’ effect thus, artificially inflating the pump price.
Third, there was no mechanism to nab tax evaders even as millions of transactions would happen without invoicing (this was exacerbated by indiscriminate use of cash for payments) causing huge loss of revenue to the exchequer. Further, the manner in which certain taxes were crafted, the system was susceptible to corruption. For instance, Gujarat imposed ‘purchase tax’ on that portion of inputs/consumables used for making urea that is sold outside the state. This prompted firms to manipulate consumption of inputs to reduce their tax outgo.
Fourth, because of several taxes and nuances associated with administration of each, businesses had to interface with multiple authorities at different levels within a state as also across jurisdictions all over the country. This increased ‘transaction cost’ – an all catch word for miscellaneous expenses such as intermediation charges, legal fees, communication charges, cost for seeking information, labor cost etc. These are sunk costs and don’t add any value.
Under GST, a ‘single tax’ applied uniformly all over India is a big positive. It removes inter-unit discrimination merely on the basis of location and allows each enterprise to determine its competitiveness in sync with what it does. Further, by enabling the supplier claim credit for tax paid on inputs, it eliminates the cascading effect. He must also declare his transactions or else he won’t get input tax credit. That helps in reining in tax evasion. Finally, by minimizing scope for discretion, it seeks to put a lid on corruption.
But, there are several lacuna in implementation which have come in the way of realizing the full potential of GST be it in terms of reducing the cascading effect or increasing the number of tax payers or bringing about the desired buoyancy in revenue collection and above all, making the tax regime simple.
First, major items such as crude oil, natural gas, petrol, diesel, aviation turbine fuel (ATF), electricity, alcohol etc have been kept out of GST. Technically, the first 4 are included, but by giving them a ‘zero rated’ tag, these are effectively excluded (as per the constitution amendment Act, GST Council has the mandate to remove this tag; but it is highly unlikely that this happen in the near term). In other words, these continue under the old regime with all its negative effects.
Being outside GST, oil and gas companies can’t claim credit for the taxes paid on their purchase of inputs, consumables and equipment leading to higher base price which increases further on account of high CED/VAT and their cascading effect. Being used in almost every sector of the economy, the high cost of these products produces an all round inflationary impact.
The exclusion of electricity generation and distribution from the ambit of GST continues to be another thorn in the flesh. Being exempt from levy of CENVAT and VAT, power companies don’t get any credit for taxes paid on inputs viz. equipment and stores etc used in its generation and distribution. This results in higher cost of electricity. Furthermore, Entry 53 in State List of the Seventh Schedule under the Constitution, empowers States to collect duty on sale of electricity (except when it is consumed by the union government or Railways). Since, no offset is available, this further exacerbates the cost.
Like petroleum products, power too is used in all sectors of the economy and its high cost has a debilitating effect on all enterprises – big, medium or small,
Second, GST architecture that we see is not as simple as it was originally contemplated. As against a single GST @12% recommended by a committee under Dr Vijay Kelkar (set up by the 12th Finance Commission) and a three tier structure viz. 12% (essential), standard rate (17-18%) and 40% for demerit goods mooted by then chief economic adviser (CEA) Dr Arvind Subramanian, what we have on the plate is 5-tiers viz. nil (essential), 5% (daily use), two standard rates 12% and 18% and 28% (de-merit). Including cess on the demerit items, the number of rates will increase further.
Even the rates particularly in the highest slab are high. Although, the number of items in 28% slab has been reduced, a number of common use items viz. cement, scooter etc continue in this slab. Even in services, areas of interest to the common man such as telecom services, the rate is 18%. If, tax incidence remains high, making the system free from cascading effect is no consolation.
Third, the system has not resulted in desired increase in tax revenue. True, businesses registered under GST at about 12 million are nearly double than the number under the erstwhile regime at 6.6 million. But, 75% of registered entities (they have turnover less than Rs 10 million) contribute a miniscule 6.5% of the total revenue. This includes 1.5% by those with turnover < Rs 2 million and 5% by those with turnover in Rs 2 million – 10 million range. The sole reason behind this is a very generous treatment of small businesses.
GST Council decided to exempt businesses having annual turnover less than Rs 2 million from payment of tax. Further, it allowed trader/manufacturer with turnover less than Rs 10 million to opt for ‘composition scheme’ under which it pays tax @1%. These thresholds have since been increased to Rs 4 million and Rs 15 million respectively (32nd meeting of the Council on January 10, 2019). This means that more businesses will join the ranks of those not paying at all or paying miniscule resulting in less collection.
Finally, several sectors face ‘inverted duty’ structure. For instance, ammonia and phosphoric acid are raw materials used in the manufacture of complex fertilizers (read: finished product). While, GST on the former is 18% and 12% respectively, on the latter, the tax rate is 5% only. This leads to a situation whereby output tax liability is not adequate to pay for input tax credit (ITC) resulting in ‘un-absorbed’ tax credit. This subjects the concerned enterprises to serious loss. The Council has pledged to address this anomaly but, no action is visible.
To conclude, three years after launch, GST is still work in progress. There is urgent need to bring all left out items particularly oil and gas products and electricity under its purview. The number of slabs must not be more than 3 viz. 5%, 12% and 18% with proviso to dispense with 18% within a set deadline. The exemption and concessions – an anathema to the very concept of indirect taxation – should go (ease of doing business does not mean, small units are allowed to pay to the government less than what they collect from consumers). The inverted duty anomaly needs to be tackled on top priority.