by Vivek Kaul
This basically happens because goods move between states twice and a 2 per cent central sales tax has to be paid each time. As mentioned earlier, tax paid in one state cannot be deducted while paying more indirect taxes in another state. This essentially means that a programme like Make in India has to face many problems before it can take off.
Other than central sales tax, state governments levy entry taxes as well. These can be, like octroi, in order to fund a local municipal body, or otherwise. These taxes are collected while goods are entering the state or a town. This explains, to a great extent, why trucks in India move as slowly as they do. This essentially drives up logistical costs.
As the Subramanian Committee report points out:
One study suggests that, for example, in one day, trucks in India drive just one-third of the distance of trucks in the US (280 km vs. 800 km). This raises direct costs (wages to drivers, passed on to firms), indirect costs (firms keeping larger inventories), and location choices (locating closer to suppliers/customers instead of lowest-cost location[s] in terms of wages, rent, etc.). Furthermore, only about 40 per cent of the total travel time is spent driving; checkpoints and other official stoppages take up almost one-quarter of [the] total travel time. Eliminating check-point delays could keep trucks moving almost 6 hours more per day, equivalent to [an] additional 164 km per day – pulling India above [the] global average and to the level of Brazil. So, logistics costs (broadly defined and including firms’ estimates of lost sales) are higher than the wage bill or the cost of power, and 3-4 times the international benchmarks.
This will be taken care of if the GST becomes the order of the day. The entry taxes will be subsumed under the GST. This will lead to a dismantling of check-posts at state borders, and there will be no need for trucks to be held up.
Around 72 per cent of Indian freight moves by road. Hence, eliminating check-posts will lead to the faster movement of goods through the length and breadth of the country. It is estimated that “eliminating delays at check-posts will yield additional savings of 0.4-0.8 per cent of [the] sales [of companies]”.312
While the state governments are yet to agree to the removal of border check-posts, as and when this happens, it will be one of the bigger benefits of the GST. If it doesn’t, it will make the GST a little less useful. At least in theory, the GST brings down Big Government.
The GST will subsume multiple indirect taxes. Take a look at Table 6.3. It lists out the indirect taxes which would come under the GST and the indirect taxes which wouldn’t.
Table 6.3: Taxes subsumed under the GST and those left out of it.
Taxes to be subsumed under the GST Taxes to be left out of the GST
Central GST State GST Basic Customs Duty
Central Excise Duty Sales Tax Export Duty
Additional Excise Duties Entertainment Tax Road & Passenger Tax
Service Tax Luxury Tax Toll Tax
Countervailing Duty Taxes on lottery, betting & gambling Property Tax
Special Additional Duty of Customs Octroi & Entry Tax Stamp Duty
Surcharges & Cesses levied by the Centre State Cesses & Surcharges Electricity Duty
Central Sales Tax Purchase Tax Entertainment Tax levied by local bodies
Source: CRISIL Research.
While the GST plans to subsume many indirect taxes, it does leave out several taxes as well. Hence, in that sense, the GST is not the one nation-one tax that it is being made out to be.
The GST will take the cascading effect of tax on tax out of the equation. It will allow input tax credit for indirect taxes that have already been paid, irrespective of what kind of indirect taxes have been paid and where they have been paid.
Take a look at Table 6.4. It explains how the GST is expected to work.
Table 6.4: How the GST works.
Source: Professor Mukul Asher of the Lew Kuan Yew School of Public Policy, National University of Singapore.
There are three levels in Table 6.4—the manufacturer, the wholesaler and the retailer. Let’s start with the manufacturer, who sells a product for Rs. 600 to a wholesaler. He does not purchase any inputs and makes everything in-house. (I know this is an unrealistic assumption, but it keeps the calculations simple.)
On this, the manufacturer pays a tax at the rate of 10 per cent, which amounts to Rs. 60. The wholesaler sells the product for Rs. 800. On this, he has to pay a tax at the rate of 10 per cent. This amounts to Rs. 80, but he also gets credit for the Rs. 60 indirect tax which the manufacturer has already paid. Hence, his tax outflow amounts to Rs. 20.
The retailer finally sells the product for Rs. 1,200. On this he pays tax at the rate of 10 per cent. This amounts to Rs. 120. But he gets credit for Rs. 80 (Rs. 60 paid by the manufacturer and Rs. 20 paid by the wholesaler). Hence, he actually pays a tax of Rs. 40. In this way, there is no cascading effect and all the tax that has already been paid is taken into account.
What this also tells us is that the GST is a destination-based tax and will finally accrue to the government once the final customer has bought the goods or services. This explains why political parties that rule states like Bihar and Uttar Pradesh have come out in its support. While these states may not have a large industrial base, they do have consumers.
The GST has a self-policing feature built into it. As the Subramanian Committee report points out: “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.”
This, theoretically, should be one of the biggest benefits of the GST over the long term, as it would make the entire system more transparent. Having said that, this could also bring down the price competitiveness of unorganised players, as they would have to go legitimate in order to keep their businesses going. This would increase their costs and could help the more organised players, who already have a strong information technology infrastructure in place.
But there might be some starting troubles on this front. The onus is on the end customer/consumer, if he wants to take the input tax credit, to prove that all the suppliers in the value chain have paid their share of taxes. This is as per Section 16(11)(c) of the Act. Basically, what the section says is that, if a supplier has not furnished proper returns or made the correct payment, then the customers of the supplier cannot avail of the input tax credit. And if it has been given, it will be reversed.
Furthermore, a lot depends on what rate of tax is decided upon. This is something that the GST council, headed by the Finance Minister, needs to decide upon. The Subramanian Committee has basically recommended four rates of taxes: a rate of 2 to 6 per cent for precious metals; a low rate on goods of 12 per cent; a standard rate on goods and services between 16.9 per cent and 18.9 per cent; and a high rate on goods of 40 per cent.
It is important that the GST council choose a reasonable rate of tax. The unweighted OECD (Organisation for Economic Co-operation and Development) average rate for the GST was 19.1 per cent in 2014 and 18.7 per cent in 2012. The recommendation of the Subramanian Committee of a standard rate of 16.9 per cent to 18.9 per cent is in line with the OECD average.
Given that the current rate of service tax is 15 per cent (including the cesses), a tax rate of 16.9-18.9 per cent is likely to make services expensive in the short run. This basically means that stuff on which you pay service tax (from your mobile phone bills to your credit card bills) is likely to become more expensive.
One estimate expects inflation, as measured by the consumer price index, to go up by 60 basis points in the short term.313 This will be in line with global evidence, where inflation does go up in the short term wherever the goods and services tax is actually implemented.
By the time the GST becomes the order of the day, the next Lok Sabha elections will be around one to two years away. Will the government be willing to take on this risk? In the
run-up to the Lok Sabha elections, the rate of inflation, as measured by the consumer price index, anyway goes up as the government increases spending on subsides.
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The state governments have come around to the idea of the GST primarily because it allows them access to tax services, which hasn’t been the case until now. The GST being adopted has a dual structure, with both the union government as well as the state governments levying a GST. Both the central GST and the state GST will be levied on every transaction of the supply of goods or services happening within a state. The taxes will not be levied on exempted goods and services.
Under the system as it currently is, multiple exemptions are available. Close to 300 items are currently exempt from central excise duty. Over and above this, nearly 90 items are exempt from the state-level VAT. These items will be merged with the final exemption list under the GST regime.314
It needs to be mentioned here that the longer the list of exempted goods and services, the higher the standard rate of the GST will have to be. Given this, the government will have to limit the number of exemptions if it wants a proper GST.
Other than central and state GST, there will be an inter-state GST for transactions happening between states, and this will be collected by the union government. The inter-state GST will be roughly equal to the central GST plus the state GST. Input tax credit will be available on the inter-state GST.
The question is: What will the final GST rate turn out to be? Or will there be multiple rates? Even though the former Union Finance Minister P Chidambaram, of the Congress Party, has been talking about a standard GST rate of 18 per cent, the Finance Minister of Kerala, Thomas Isaac, has remarked that capping the GST at an 18 per cent rate is too low. Other finance ministers have said the same thing. Isaac has recommended a standard rate of 22-24 per cent in order to ensure that states do not lose out on revenue.315 The situation at the time of writing this, in August 2016, seems to suggest that a standard rate of 20 per cent or more will be arrived at.
To this, Arvind Subramanian, the Chief Economic Adviser to the Finance Ministry, has said that a standard rate of “higher than 18-19 per cent will stoke inflation”.316 This is primarily because the tax on services, which is currently at 15 per cent, would see a huge jump.
It remains to be seen what rate the GST council finally comes around to. Take the case of small cars. Currently, an excise duty of 12.5 per cent is levied on them. Then there is the state-level sales tax (or VAT) of 12.5-14.5 per cent. The Union Budget for the year 2016-2017 added a 1 per cent infrastructure cess on cars. Over and above all this, some cities charge an octroi as well. Hence, we are talking about an effective tax rate of around 28 per cent. If the standard rate of GST is 18-19 per cent, then the prices of small cars should come down.317
CRISIL Research expects the prices of small cars to come down by about 10 per cent.318 But this is assuming that the state finance ministers come around to the idea of an 18 per cent standard rate of GST. As the senior journalist and editor R Jagannathan put it in a column: “Why would any sensible finance minister at the Centre or states reduce this to 18 per cent?”319 This will continue to remain a tricky issue, given that states need to subsume a whole host of taxes under the GST and are likely to demand (in fact, they are already demanding) a standard rate of 20 per cent or more.
Also, there is the question of how states will compensate municipal corporations for the taxes that are subsumed under the GST. Take the case of octroi. The Brihanmumbai Municipal Corporation makes a lot of money through octroi. If the GST were to become the order of the day, then octroi would get subsumed under it.
As Jagannathan puts it: “The Mumbai Municipal Corporation’s Octroi collections annually are in the range of Rs. 7,000-8,000 crore. Will GST collections in Maharashtra be enough to finance this revenue loss?”320 This is a question worth asking.
Furthermore, the GST system, as it has been envisaged, will need a solid information technology backbone. This information technology system would essentially lead to a lot of lower level bureaucracy, which runs India’s indirect tax system, becoming useless. (Think of all those employees manning check-posts on state borders, for one.)
While the government does not fire employees, a move towards the GST would lead to the income from corruption for the lower level bureaucracy coming down. And this is unlikely to go down well with them. They, as always, remain in a position to create problems.
Also, in an interaction with a senior economist, who is closely involved with the GST, in July 2016, I was told that the state-level bureaucracy remains unprepared for the implementation of the GST. The fact that the GST is a destination-based tax and not an origin-based one, which is one of its core points, remains unclear to many of them.
Given that there is the risk of the revenues of the state governments falling for the first few years after the GST is introduced, for the first five years the union government will have to compensate the states for the loss of revenue arising due to the GST. This is the known unknown that can really create a problem. If the compensation demands from states are more than what is expected, the fiscal deficit of the central government can shoot up.
In this scenario, achieving the fiscal deficit target that the Finance Minister, Arun Jaitley, has set for the government will become difficult. In the budget speech made in February 2015, Jaitley had said that the government would achieve a fiscal deficit of 3.5 per cent of the GDP in 2016-17 and 3 per cent of the GDP in 2017-18. Running up a higher fiscal deficit will have its own set of repercussions.
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As we have already seen, the GST is basically a self-policing system and makes the entire system more transparent. The Subramanian Committee report points out that the GST “is a stark example of a tax believed to facilitate enforcement through a built-in incentive structure that generates a third-party-reported paper trail on transactions between firms, which makes it harder to hide the transaction from the government.”
This basically ensures that the tax collected by the government goes up. As the analysts Saurabh Mukherjea, Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital point out: “Cross-country evidence suggests that the introduction of [the] GST boosts the tax-to-GDP ratio by 1-2 per cent points.”321 The analysts feel that the GST will boost tax collection in India by bringing the unorganised sector, which accounts for 59 per cent of India’s economy, under the purview of taxation.
While the rate of inflation is initially expected to go up, over the longer term the inflation should come down as the cascading effect of indirect taxes is done away with and the cost of doing business comes down. How has the global experience been on this front? In New Zealand and Canada, the introduction of a single GST brought down inflation. But that wasn’t the case in Australia and Thailand. In these two countries, inflation went up, but this was more due to domestic supply constraints. Once these factors were adjusted for, inflation in Australia and Thailand was also lower after the implementation of the GST.322
And what about economic growth? Does the GST add to economic growth? According to Finance Minister Jaitley, speaking in April 2015: “This [the GST] has the potential to push India’s GDP by one to two per cent.”323
The passage of the GST adding to economic growth is something that has been reiterated over and over again by those who have been in favour of it. As far as Jaitley’s statement is concerned, it was probably made on the basis of a December 2009 report brought out by the National Council of Applied Economic Research (NCAER). In this report, NCAER said that, other things remaining the same, the implementation of the GST is likely to push up India’s GDP “somewhere within a range of 0.9-1.7%”.324
The evidence for the GST increasing GDP growth (or economic growth) is at best sketchy. The cross-country evidence seems to suggest that the GST brings down the inefficiencies of the indirect tax system as it was prevailing before the GST was introduced. But there is no conclusive evidence for the introduction of the GST leading to fast
er economic growth.325
To conclude, there are many good things about the GST. Nevertheless, it is not a done deal yet and a few major issues remain which will continue to test the Modi government in the days to come. Also, the success of the GST will depend on the extent to which the new system limits the vagaries of the current Big Government in India’s indirect tax system.
Furthermore, it is not the be-all and end-all that the media is making it out to be. It is just one of the factors that will help to set India right in the years to come.
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In this last section to this chapter, let’s briefly look at some of the other factors that need to be set right if Make in India is to become a success.
a) Labour Laws: This is one reform that the government needs to push through seriously. The trade unions will of course create a lot of problems. And no government till date has been able to take them on. But if Make in India has to happen, India’s labour laws need to be reformed big time and at a rapid pace. Only then will the smaller Indian firms become bigger and, in the process, create more jobs in the organised sector than currently is the case. This is discussed in detail in Chapter 7. The current Modi government has only taken some baby steps towards this.
b) Land Acquisition: The way things currently stand, it is next to impossible right now to acquire land in India to set up a factory. And setting up a factory is not possible without the acquisition of land. The issue has become too complicated over the years, given that, until 2013, the Land Acquisition Act of 1894 was the law of the land. This is discussed in detail in Chapter 8.
As mentioned earlier, a new window of opportunity has opened up thanks to China. With Chinese labour costs going up, industry is moving out of China in order to stay compatible on the price front. Until now, these industries and jobs have moved to countries like Vietnam, the Philippines, Cambodia and Bangladesh. If these industries are to move to India, then a focused effort is needed in sorting out issues like land acquisition and labour laws in order to promote manufacturing and industry within India.326