Judged by the kind of political challenges that important economic reform measures present to the UPA government ?think land acquisition, financial sector liberalisation, and labour laws to name just three?the implementation of a goods and services tax (GST) is relatively low-hanging fruit.
Most importantly, there is little in terms of intellectual opposition to reforming our complicated indirect tax system. Despite the vast improvement brought by the implementation of VAT, there are still far too many, usually cascading, indirect taxes in the economy. What is worse, they are not uniform across the country, varying greatly across states, something that prevents the economy from reaping the enormous benefits that are associated with a genuine single market. Needless to say, too much power remains in the sphere of a discretionary government tax apparatus that lends itself to unproductive lobbying, rent-seeking and corruption. A single GST (with separate components for Centre and state) can rid the indirect tax system of all these problems, while increasing the tax base (good for governments) and contributing to additional GDP (with massive benefits to both producers and consumers).
Yet, progress on GST, originally scheduled for implementation on April 1, 2010, is in stalemate amidst disagreements between the Centre and states. The time frame is actually the least of the problems?a delay is acceptable if it will eventually lead to a better system. What is more worrying is the potential dilution of the final goal of a single GST. Ostensibly, states are objecting to the recommendations of the GST task force set up by the 13th Finance Commission for a ?revenue neutral? rate of 12% (with 7% for states and 5% for Centre). Despite all the thorough mathematics (see the GST taskforce report that uses at least five different methods to substantiate its calculations) that indicate otherwise, states insist that this is not a revenue neutral rate and are demanding more.
The real problem is more complex and relates to the political economy, not arithmetic. GST involves a clear move away from source-based taxation to a tax on final consumption, and that?s an unambiguously good thing. However, that fundamentally changes how tax is collected across the country and by whom. It?s obvious that states that have higher levels of consumption will collect more taxes. So richer states, whose populations consume more (than they produce), like Gujarat or Delhi, will gain revenues. Conversely, states that consume less, like Bihar and Orissa, stand to lose?in the current system, they at least generate revenue from source-based taxation levied on industries (particularly resource-based) in their states. In a consumption-based system, they lose that advantage. So, there is a distribution issue between states.
Unfortunately, even the states that stand to gain are not putting their weight behind the current proposals in the hope that they will get more if there is an upward revision in rates?the greed factor.
The other strong interest group which would be only lukewarm to the introduction of GST is the tax establishment at the Centre and in states. At the Centre, a simple 5% GST will greatly reduce the turf of the Central Board of Excise & Customs and their discretionary powers. Even in the states, once indirect tax is consumption-based, there is less power and no discretion for tax inspectors who are used to collecting taxes at the factory door.
The two interest groups that should support GST without reservations have their own problems. Industry should welcome GST because it will eventually bring down costs and, critically, bring a level playing field with imports (there will be a standard countervailing duty, at the GST rate, on all imports), but they get distracted by the task of seeking exemptions. Consumers, who will also gain from a lower tax burden, suffer from the perennial problem of organising collective action.
If policy is ultimately decided by the weight of relative interest groups, things are not looking bright for an uncompromised GST. Those who should support GST are either not organised or distracted by greed and exemptions, while those opposed are quite focused.
The one thing worse than GST not being implemented at all is the implementation of a flawed GST, evolved out of compromise. So, a GST at the rate of say 20% will be a mistake?that will simply encourage evasion and potentially reduce the tax base. At any rate, it won?t lower the indirect tax burden from what it already is?around 24%. The other fatal mistake will be to enforce two different rates of GST, low and high. This will lead to lobbying and rent-seeking as everyone tries to get their good or service included in the lower rate category.
What we need now to salvage a flawless GST is a strong intervention from the Centre, preferably from the finance minister or Prime Minister. If necessary, the Centre should be ready to offer a ?grand bargain? to protesting states. So, for example, if some states lose revenue after GST, the Centre can promise to compensate them?Chidambaram as FM offered something similar at the time of VAT. Alternatively, if a marginal increase in rate to say 13% will allow a flawless GST, the Centre should offer it. Also, if 12% turns out not to be revenue neutral, the Centre can promise to tweak the rate later.
Unfortunately, the Centre hasn?t indicated any thinking on these lines so far. Someone needs to urgently take ownership of a fabulous policy idea called GST.
dhiraj.nayyar@expressindia.com