The Empowered Committee of state finance ministers (EC) presented the First Discussion Paper on November 10, 2009, on goods and services tax (GST) in India detailing the comprehensive structure of the proposed GST model. The discussion paper perceived GST as a logical step towards comprehensive indirect tax reforms in the country.
The government of India is of the view that there should be no distinction between goods and services for taxation purposes. The Thirteenth Finance Commission (TFC) outlined the design of a model consumption type GST with a common taxable event and tax base. The consensus seems to be for a dual GST?one levied by the Centre (central GST) and the other levied by the states (state GST), with dual rates. The TFC also suggested the introduction of GST with not more than two rates. Any model of GST shall ultimately reflect the economic and political realities of the country.
Although it has been proposed that the central GST should subsume Cenvat and additional excise duties, countervailing duty on imported goods, service tax, and all surcharges/cesses, the TFC projections assume continued revenue for the central government from cesses throughout the 2010-15 period. Cesses and surcharges constitute about 10% of the gross tax revenue of the Centre, and if they were to be included in the shareable pool on implementation of the GST, the gross tax receipts and correspondingly the revenue neutral rate (RNR) will need to be recalibrated to ensure invariance in the net tax receipts of the Centre.
As far as the states are concerned, GST would effectively mean VAT plus service tax collected at the place of consumption with the cascading effect of Cenvat being removed and access to credit being allowed across goods and services. While a Rs 50,000-crore central grant has been proposed as part of the ?grand bargain? to implement the GST, there has been no discussion in the TFC report, nor elsewhere, as to which all states, if any, are likely to gain or suffer revenue loss from the implementation of the GST. It may have been more appropriate to determine the likely revenue impact before working out the grant size necessary to compensate the states. The primary issue may not be the amount available for compensation but the psychological comfort provided to the states to enable them to move with confidence. Some states do have legitimate concerns about a permanent loss of tax base such as subsumption of purchase tax. These issues need appropriate responses.
As a first step in this direction, an attempt is made in this article to estimate the likely gain by individual states from being allowed to collect the service tax. We do not start from first principles using a theoretical or conceptual approach, as, for example, adopted by the task force of the TFC. State-wise share of service tax collection is estimated on the basis of the service tax regime as it existed in 2007-08, which was the last year prior to the global financial crisis. The task force also took 2007-08 as the base year for computation of the RNR.
The objective is to assign Rs 51,133 crore collected as service tax during 2007-08 at the mean rate of 10%, to individual states, based on the destination principle. No adjustments are made here for the rate changes, as may be necessary to arrive at the RNR.
The practice at the Centre is to collect service tax at origin, treating the whole country as a single taxing jurisdiction. Service tax assesses with multi-locational supply have the option to make centralised payments. A shift to the destination principle would require re-allocation of service tax collection using proxies that are relatable to consumption of the corresponding services. With respect to five major categories of services, which contributed 53% of the total service tax revenue, specific proxies that are closely relatable to consumption of these services have been adopted (see table). For the remaining services proxies such as the share of annual income, annual expenditure, Gross State Domestic Product (GSDP), services GSDP, gross value added as per the 63rd Round of NSS (covering other than mainframe units) have been adopted. The average of the estimates made using each of these proxies, along with the state-wise service tax collection under the existing dispensation have been used in this analysis. The following observations flow from these estimates.
First, the changeover from the origin to destination principle implies a reduction in collection to originating states such as Maharashtra and Delhi. The major beneficiaries in percentage terms would be the consuming states such as Jharkhand, Bihar, Chhattisgarh, Assam and Kerala, and in absolute terms would be Uttar Pradesh, Kerala, Bihar, Andhra Pradesh and West Bengal. These states have a higher percentage share of expenditure as compared to income. However, it may be noted that this analysis is indicative and restricted only to the service tax component. Correlation need not necessarily amount to causation. A fuller analysis is required that incorporates the impact of taxation of goods as well in the new regime.
Second, Rs 9,699 crore (or 16% of the total service tax payable) of service tax was paid through credit availed on inputs. However, the mean Cenvat rate of 16% during the relevant year was significantly higher than the mean VAT rate. Therefore, the estimates are conservative and have an upward bias.
Third, service tax base, at the 2007-08 levels, works out to Rs 6,00,000 crore (12.7% of the GDP). In our view, there is substantial scope to widen the service tax base further, as the net value addition in services available for taxation in 2007-08 works out to be significantly higher in terms of the CSO Input-Output Transactions Table, 2003-04.
The revenue gain estimated from services needs to be netted against the revenue loss, if any, on account of removal of the cascading effect of Cenvat and the input credit of service tax for payment of GST on goods, for arriving at the likely net revenue impact on individual states.
The convergence of rates into a single GST rate will also throw up its own dynamics in the context of Centre-state fiscal relations. With the implementation of GST, it will also be possible to vary the scheme of devolution to the states by way of, say, inter se tweaking of tax rates between the Centre and states, even at the levy stage, rather than only at the appropriation stage, as was the case earlier. Hence, the interface between the EC or any new institutional mechanism and the Finance Commission also assumes major significance in the new regime.
?The authors are civil servants. Views are personal