With the Centre making its views public on the empowered group of ministers? proposals on GST, we are now into the final stages of implementing a unified indirect tax system across the country. Looking back at the milestones in the road to GST?the empowered committee discussion paper released on November 10, 2009 and the task force report on December 15, 2009?there are significant differences in the perceptions of the Centre and the states regarding the uniformity of rates, the list of exempted goods and the coverage of products and taxes to be subsumed.

In principle, the implementation of GST would be a watershed in the economic history of India, since it will be the first step towards the creation of a common economic market for goods and services in the country. Ideally, GST implies a common tax rate applicable on the value added in each stage of the production of goods and services, which replaces all existing forms of indirect taxes, including customs, state and central sales tax and state and central excise tax. A common tax rate would mean that operational efficiencies, and not fiscal incentives, will determine competitive advantage among firms. This will result in more rational business decisions. Also, various advantages concerning the location will be better reflected and cost structures better managed. By avoiding the cascading effect of the conventional tax system, the overall cost of production would decline and contribute to lowering of prices and thus benefit the consumers. From a fiscal point of view, a simpler and more rationalised tax system, with a system of input credits, would be easier to administer and would improve tax compliance and reduce tax evasion, thus leading to higher net revenues for the government. A unique feature of the Indian system will be that the GST would be made up of two rates taking into consideration the federal structure – central GST and state GST.

The benefits of GST may be better understood through a simple example. If a producer (under the present tax net) purchases an input good which costs Rs 100, and manufactures an additional amount of Rs 40, he/she would have to pay 12.5% Value Added Tax (VAT) on the net sum cleared from the factory, excise of 8% on the cost of production and 2% Central Sales Tax when goods are transported inter-state. This excludes service tax and various other state-specific taxes like entry tax and purchase tax, depending on the nature of the sector and the state in question. Even in the best scenario (taking only intra-state transactions), the total tax payable would be Rs 16.2 and if the entire tax is passed through, the best price for the commodity becomes Rs 156.2. On the other hand, under a GST system assuming a 16% consolidated tax rate (8% by the Centre and 8% by the state), the total tax would amount to Rs 6.2 (22.4 – 16 input credit) and the product price to Rs 146.2. Hence, the manufacturer, even under the best pricing scenario, will save at least around 7% of the total cost of production.

The example is however, based on assumptions which also lie at the centre of differences between the Centre and the states on GST. Firstly, for the benefits to be realised, all input costs (as far as possible) should come under the tax net. This would mean pruning the exemption list and establishing a uniform exemption list throughout the country. Currently, there are 330 exemptions under CENVAT and 99 exemptions under the state VAT, which is significantly high. The Centre appears to be in favour of considering the state VAT exemption list in GST and establishing parity between central GST and state GST. There are discordant noises among states for establishing state-specific lists or higher exemption lists and this will have to be sorted out. Also, the perspective of the states that petroleum products be kept out of the GST framework, could result in cascading. Crude oil and petroleum form major inputs for products such as ATF, diesel, motor spirit and other refined products such as naphtha and lubricating oil, which in turn have cost implications for key infrastructure and transport segments such as roads, aviation, railways and urban para-transport. The Centre feels these products should be included in GST and this appears to be a prudent move.

The rationale for a tax-neutral indirect tax system would require that all state and central indirect taxes be subsumed under the new regime. According to the task force discussion paper, electricity duty, octroi and local body taxes should be left out of GST. Also, some states have expressed reservations over purchase tax being included. While in the task force paper the GST structure is a significant improvement over the current tax regime, the above mentioned taxes would strengthen the GST structure.

Another key issue would be the threshold limit or the minimum limit beyond which firms are exempted. Prudent taxation principles would suggest that the threshold be as less as possible to a point where the cost of tax administration exceeds the revenue benefits per firm. In order to avoid fiscal disparities, the threshold should be as uniform as possible across states. A uniform threshold of Rs 10 lakh turnover appears to be prudent and the ministry of finance also appears to be veering around this view. But negotiating a uniform threshold at this level across states would require deft political management. The ministry of finance has pointed out that the threshold would not apply to inter-state supplies. Also, the ministry of believes that the problem of dual control would better addressed through a compounding scheme as well as administrative simplification for small dealers through several specific measures. Prima facie this appears a reasonable position.

A key issue is that of fiscal implications on state and central finances. State taxes comprise a significant portion of state revenues. The same ranges from 18%-51% of revenue receipts of major borrowing states in FY09. While the state GST would be levied by the state, state governments would lose the policy flexibility in determining state tax rates under GST. This would mean that state revenues would be increasingly aligned to economic growth and the chief triggers for revenue buoyancy would shift from tax rate changes to fundamental improvements in the state economy. State governments would have a greater incentive to invest in growth inducing reforms and capital outlay.

The recent moves towards GST represent a path-breaking process towards redefining the Indian taxation system to a more rational and efficient revenue set-up. The proposition of lowering tax rates corresponding with higher tax receipts appears to have relevance in Indian fiscal history and implementing GST would also help support economic growth.

The writer is MD & CEO, CARE Ratings. The views are personal