GST: The Good and The Scary (II)

It took us 16 years to pass the GST bill in the Parliament. These years have seen a copious amount of political debate, numerous committee reports, backtracking, stalling and convincing. The GST is undoubtedly one of the biggest, but also one of the most contentious reforms of our country. In the last post, I had discussed the various positive changes the reform can bring about; this post deals with the ‘scary’ part: the questions that remain and the possibilities of mishaps. Though, ‘scary’, and not certainly ‘bad’. The points below will move progressively from the neutral issues to the mildly contentious to finally the scariest issues:

1) REVENUE NEUTRAL RATE:
This point makes it to this list, not because of its inherent implications, but keeping in mind how widely it is misunderstood as a benefit: the elimination of the cascading effect will not reduce the tax liability on a consumer.

A tax-payer only cares about the total amount of tax he is paying at the end of the day. Whether that tax constitutes a cascading burden is immaterial to him unless the absence of this burden will reduce the overall tax payable by him—which is not the case. A revenue neutral rate is one that generates the same amount of revenue for the government, before and after the reform. Therefore, the GST rate will be set such that, in effect, it taxes the consumer at least as much as the old system did with the cascading effect.

2) INFLATION
To a large extent, whether the GST will lead to inflation depends on the GST rate that is set. In general, tax on goods will reduce and on services will rise. It is highly likely that the reduction in the former will not offset the steep rise in the latter, at least in the short term. Also, specific goods might become more expensive in different states depending upon how those goods were taxed in those states. But according to Urjit Patel, 55% of the CPI basket will not be impacted by GST and therefore there may only be a mild impact on inflation.

3) INTER-STATE RELATIONS
The GST system will change our taxation principle from ‘origin-based’ to ‘destination based’ (due to reasons that were discussed here). This change will lead to a shift in revenues from the production-heavy States to the consumption-heavy States. For instance, Delhi has a huge consumer base that imports goods from different States including Haryana, a State which generates a high volume of industrial output. With the GST, the Haryana government may lose a large portion of its revenues to Delhi.
It was for this reason that the AGST was proposed and the 5-year compensation plan has been put in place. But will this be enough to prevent any acrimony between States in the long run?

4) GST Council Governance
The GST Council will resolve any disputes arising among the States. Further, every State has an equal voting right within the State. While that might sound pleasingly democratic, as Ajit Ranade noted, “Is this fair? Large producing states like Maharashtra already fear losses in excess of Rs.14,000 crore in the first year itself. It is asking for larger reimbursement. Other voting states may “gang up” against Maharashtra and veto such a proposal. What if a larger state wants to impose a higher “sin tax” or give a bigger subsidy at the lower end of the GST slab since they can afford it? Will the current governance framework provide such a leeway?”

5) RATES CANNOT BE ADJUSTED TO THE SPECIFIC NEEDS OF A STATE
The big advantage that the GST confers in terms of uniformity in tax rates across States also poses some problems, or rather the lack of some of the advantages of a state-wise adjustable rate system. For instance:

  1. To foster regional equality, the Centre sometimes reduces the Excise chargeable in particular states (not just SEZs) like Sikkim and Himachal Pradesh, to give them a competitive advantage in attracting investments. These States, left to themselves, will be stuck in a vicious cycle of low development therefore low investment therefore low development and so on.
  2. Some States may exempt goods that are of local importance to that State. Examples:
    • Thaalis are exempt from tax in Tamil Nadu
    • Uttar Pradesh does not tax Banarasi Saree as they are of cultural significance
    • In Maharashtra, VAT is not levied on Solapuri Chaddars
  3.  Some States which enjoy an inelastic supply of investments will lose out on the extra revenues they could have earned if they were allowed to set rates for themselves.

At the end of the day, there is a trade-off between the advantages of a uniform rate and of a multiple-rates system. It can be argued that the former trumps the latter, but the loss in the absence of the latter cannot be denied.

6) EXEMPTIONS
The GST will be non-applicable to the tax on petroleum products, electricity, alcoholic liquors, and stamp duty on immovable property. Instead, the current system of Excise and VAT/CST will remain applicable to these items. This has purportedly been done to smoothen the transition to the GST as these items constitute close to 40-50% of different states total tax revenues, and these exemptions are expected to be phased out gradually. If the phasing out is done timely, the short-term drawbacks can easily be overlooked. But as a country, we are notorious for missing deadlines, and especially since bringing these items in may mean a further reduction in the revenues of the States, the phasing out may take a long while, or heck may not happen at all. Remember, after the introduction of VAT, the CST (part of the erstwhile ‘Sales Tax regime’) was supposed to be phased out in a similar manner, though it is still alive and kicking even today. (Read more about this Here)

Now, if these exemptions are not phased out, as I fear, they will lead to the following problems:

  1. Petroleum is an indispensable input that powers machinery in the manufacture of every commodity. If it is not under the GST system, the input tax paid on it (VAT/CST) will be ineligible to be set off against the output SGST/CGST/IGST he receives from the consumer. Therefore, there will be cascading of tax that will form a part of the manufacturer’s cost.
  2. The full force of the positive impacts of the GST on our economy will be limited by its limited applicability.

With this, I come to an end in this GST series. If you’re one of those who read all the three posts, a big thank you to you.

The other two posts are: A Simple Guide to the GST and GST: The Great and The Scary (I)

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