Introduction

 

We have reached the final stage of introduction of Goods and Services Tax (GST) i.e. its implementation on July 1, 2017. The original plan was to introduce GST from April 1, 2010, but the process got delayed by more than 7 years. This delay is a reflection of the fact that political economy of tax reform is not an easy job in a complex federal country like India.  We are finally reaching the finish line after protracted negotiations between the Union Government, 29 State governments and 7 centrally administered Union Territories and to an extent with other stakeholders.  

 

GST and the Constitution of India

 

GST also required a constitutional amendment (122nd Constitutional Amendment) to enable the Union government to tax consumption of goods and allow states to tax consumption of services. Post the constitutional amendment both the central and the state tax bases have merged and from this common base both the levels of government will collect taxes.  The Constitutional amendment enabled the creation of GST council. The Council’s Chairperson is the Union Finance Minister and States have their ministerial nominees as members of the council. Since creation of the Council in November 2016, the Council have met 14 times in the last seven months. On an overage, council meeting thus happened on a fortnightly basis bringing clarity to the design, rate structure and mechanisms for compensation under GST.  This is a commendable achievement. This also shows that Indian federal system has transformed itself as a federation where both Centre and States have learnt to trust each other and gave up their exclusive taxation rights with respect to a particular tax base for a better tax system.  This common tax base creation should result in an abolition of fragmented tax regime, development of a common market, elimination of cascading of taxes and should help increase the growth of GDP by promoting trade, business and investment.

 

Taxes to be subsumed under GST

 

Central and State taxes to be subsumed under GST are the following:

 

a) The Central taxes would include central excise duties, additional duties of excise, additional duties of customs, special additional duties of customs, service tax and central cess and surcharges so far as they relate to supply of goods and services. 

 

b) State taxes to be subsumed under GST are State VAT, central sales tax, luxury tax, entry tax, entertainment tax, taxes on advertisement, purchase tax, taxes on lotteries, betting and gambling and state surcharges and cesses so far as they relate to supply of goods and services.

 

This list shows that petroleum products, alcohol for human consumption, real estate sector and electricity duty are kept out of the purview of GST. In other words, though most indirect taxes have come under GST, a large part of it also remained outside the purview of GST. Incomplete coverage of goods and services indeed is an issue that the country needs to resolve as we move further on the path of reform of indirect taxes to get the full benefit of GST with a comprehensive coverage. However, the agreed structure is a vast improvement from the present design. 

 

Destination Principle:

 

GST would get rid of the age old regressive central sales tax (CST).  CST is a regressive tax levied at the point of production. This practice has resulted in a significant tax exportation from richer producing states to poorer consuming states contributing to fiscal inequality in the country. This precisely is the reason why some of the richer producing states are not happy with the abolition of CST and were initially opposed to the idea of GST and some are still not happy with GST.  It is expected that the revenue gain due to the expansion of base due to destination principle of taxation at the point of consumption and additional taxation of services should result in significant revenue gain to states after the input tax credit adjustment and loss of CST revenue. 

 

Has GST compromised Federalism?

 

It is certainly true that right to taxation is intimately linked with the right to decide on the rate of taxation. Post GST, individual state government would not be able to decide on the rate structure of GST in a particular state. That way for the sake of tax harmony, fiscal autonomy is compromised. This is true for the central government as well. Centre also cannot change anything without the approval of the majority of the states in the GST council. But if we examine the big picture, in a globalizing world, fiscal policy, especially tax policy has become in a way ineffective long back.  To give an example, to attract global investment, India really cannot have a corporate income tax rate which is way above the rates in other emerging market economies trying to attract same investment. The same thing is being reflected here, i.e. a process of harmonization of tax rates across the country through a process of negotiation in the GST council. In the former case, it is the market that forces a country to align rates to a particular reference in the latter case it is happening through a process of negotiations. Even with floor rates, States would have ultimately converged to a particular rate. The larger question is whether rate harmonization alone is sufficient to attract trade and investment?   Probably not. We need to have harmonization of processes. If business and trade have to face different kinds of complexities in complying with the tax laws in different states, rate harmonization would become ineffective. 

 

Finally, post-GST fiscal architecture is an outcome of the 101 constitutional amendment. It is too late to reopen this issue. Autonomy of all levels of governments including that of Union government have been tied to the GST council on matters of indirect taxation.  It is the responsibility of the Council to work in a manner that preserves and strengthen fiscal autonomy of all the levels of governments. Union government would have to take the lead in this regard. Whatever happens, this process is irreversible. 

 

Let us get the best out of it for the country!!!