The current debate misses out on one important dimension that taxation of goods and services is inextricably linked with taxation of personal incomes
The goods and services tax (GST) has been an international phenomenon with more than 140 governments around the globe adopting the regime: it has generated large revenues; reduced compliance costs of businesses; increased the ease of doing business; and in the long run, by reducing production and distribution costs, also decreased inflationary pressures. The audit trail which this tax leaves behind makes it self-policing. As a consequence, scope for evasion and corrupt practices gets substantially reduced. In India, additionally, it will subsume a large number of other taxes and create one unified market for all goods, thus ensuring that they move much faster to destinations all over the country. But how successful it is in India will depend on how well it is designed and implemented.
The tax itself works on a very simple principle of taxing the net value added. For example, if a wholesaler buys goods from his supplier for R100 and sells them to his retailer for R150, and the retailer in turn sells them to the customer for R180, the value added by the original supplier, the wholesaler and the retailer would be R100, R50 and R30. At a GST rate of 15%, they will accordingly collect from their customers and pay to the government a tax of R15, R7.50 and R4.50, respectively. The final price to their customer will thus be R207 (R180 plus R27— the sum of R15, R7.50 and R4.50 as computed above). At the same rate of tax, under the orthodox system of sales tax and excise duties, the consumer would end up paying R252.71. Such is the power of GST; it eschews the cascading effect of tax on tax.
International experience with this tax appears to suggest that the provisions of law should be simple and easy to understand; and those who implement the new provision should largely depend upon securing compliance voluntarily rather than through coercion. In practical terms, such voluntary compliance increases when taxpayers accept the system; and chances of this happening are much greater when forms are few and easy to fill.
Simplicity also implies that that the number of exemptions should be kept to the bare minimum. New Zealand is often held out as an example where GST has succeeded because the base is broad. This tax works best, it seems, when there is no distinction between movable property and immovable property; tangible goods and intangible goods; and between goods and services. The tax should extend seamlessly across the board to all commercial transactions, leaving minimum scope for disputes. Ideally, tobacco, petroleum products, real estate and alcohol should fall within the ambit of the levy.
The rates themselves need to be kept low. Ideally, a single rate works best but if that is not possible, these should be limited to two. High rates as well as multiplicity of bands have been known to militate against voluntary compliance. They result in narrowing the base which, in turn, necessitates still higher rates. The GST Council should therefore seriously reconsider its existing proposal of three tax bands. Although the GST Council has not yet decided on the general rate applicable to most goods, the finance minister has talked about 20% or higher. The government’s chief economic adviser (CEA) has indicated something between 16.9% and 18.9%. This according to him is the revenue neutral rate at which the government can maintain its existing levels of revenue.
The current debate, however, misses out on one important dimension of the problem: taxation of goods and services is inextricably linked with taxation of personal incomes: the dynamic relationship between the two is best illustrated through a small example. For the sake of simplification, let us assume that only pencils, which are priced at R10 each, are available for sale. If a consumer earns R100, he can buy 10 pencils. With a 20% tax on personal income, he can, with the R80 left with him, buy only 8 pencils. The government, however, may decide not to levy income tax, but a GST of 25%. Assuming that the seller has no tax credits to claim, he will now charge the consumer R12.50 per pencil. With an income of R100, the consumer will again be able to afford to buy only 8 pencils. The important result that emerges from this example is that a 20% tax on income is equal to a 25% tax on consumption (GST).
If the government decides to levy both income tax and GST at these rates, he will be able to purchase only 6.4 pencils. As a result his purchasing power will erode by more than a third. The question the government needs to ask is: given the current rates of income-tax, how much further can it increase GST, before the consumer starts questioning the fairness of the system? The general rate of GST must, thus, be based on a holistic view of the entire tax system. Prima facie, in the Indian context, a GST of about 15% to 18% appears just right, considering the extremely large population of poor and middle class people. Anything higher is bound to be perceived as regressive and unfair. Any potential loss in revenue would in all likelihood be more than made up by a much larger base of taxpayers and improved compliance. International experience appears to support this view.
Finally, we may perhaps agree that it is better for policymakers to be practical and deliver beneficial results quickly rather than obsess over formulating a perfect law. Writing in 1980, Michael Lipsky, former don of political science at MIT, noted that the world over public policy transforms—sometimes quite radically—from formulation to implementation. This is because, the much harried street level bureaucrats implement it according to their understanding and established routine practices. The chances of their switching off and doing what they like are much greater when the law is complex, unwieldy or cumbersome. GST Council might like to bear this mind.
Hardayal Singh was formerly chief commissioner of income-tax and ombudsman to the I-T department, Mumbai and Ashok Khanna was formerly senior partner AF Ferguson, Chartered Accountants