Challenge to insulate masses from inflationary pressure

The Goods and Services Tax (GST) is finally slated to be implemented from July 1, 2017. The unified tax system will effectively remove the ‘cascading’ effect, taxes on taxes, and will improve efficiency, minimise leakage and subsequently enhance tax collection.

The proposed GST is a destination-based consumption tax and moves the tax regime from producers to consumers, therefore transforming the incentive structure of businesses as more tax can be collected from the destination states. This shift, however, creates an imbalance as states that have developed manufacturing units will lose out in the short-run and might even start withdrawing their products if an immediate solution is not offered.

The GST will bring in a radical shift to a centralised digital set-up where all taxes can be regulated and monitored without much intervention from the tax administration. This needs massive effort to train tax officers and set-up tax networks to avoid teething problems.

The international experience shows that the success of GST and Value Added Tax (VAT) depends upon the model of taxation, tax rates and a robust system for effective implementation. The proposed GST will have a four-tier rate system at 5%, 12%, 18% and 28% for different category of products, where rates are close to the effective rates.

Some goods such as real estate, alcohol, crude oil, natural gas etc., and services such as healthcare, education etc., are not under GST. These have been left to the state governments. Therefore, the proposed GST is not going to be simple and without glitches, particularly given India’s technological literacy and inclusiveness. Therefore, the government must take a few additional steps to ensure a simpler and robust tax system.

The proposed GST regime suffers from different tax rates and multiple barriers which may lead to constant ‘rate wars’, like under the existing VAT regime. As few important sectors are left to the state domain, the objective of uniformity is partially diluted.

The goods and services that do not come under the realm of GST will again lead to the cascading of taxes and inefficiency. There are issues also on classifying products under different tax brackets. For example, goods like washing powder and services like movie tickets and telecom are considered as luxury and taxed at higher rates, though these are consumed by the masses.

India’s tax-to-GDP ratio has remained around the 16% mark since 2000, with the indirect tax to direct tax ratio of around 65:35. The ratio of direct tax to GDP is one of the lowest in the world where indirect to direct tax collection ratio is very high. For example, less than 5% of the total population pays income tax, whereas all Indians end up paying some form of indirect tax.

Indirect to direct tax ratio

The proposed GST will increase the ratio of indirect to direct tax, which is against the principle of equality as it would affect the economically lower sections. Another concern is whether the benefits to businesses from tax cuts will be passed on to the consumers or not.

In this regard, the government needs to put an effective system to ensure price reduction in line with the tax reduction to avoid inflationary pressures. Though the government has put an anti-profiteering authority in place, it would be difficult to measure the price of a good or service based on the tax rate.
The authorities could intervene if business units fix their prices not only on the basis of cost, but also on cyclical losses and profit owing to market conditions. This may lead to asymmetric information between the anti-profiteering authority and the businesses, and thereby lead to unnecessary market friction.

Therefore, the government should focus on such issues as ensuring an effective pass-through of benefits from tax reductions into retail prices, putting an effective and strong digital system for smooth functioning and include all goods and services into the GST ambit to avoid further cascading of taxes. Further, the composition of goods and services in the CPI index should be updated so that more accurate inflationary expectations could be achieved.

 The intention of the present government for a simple and effective tax system is very clear. However, there are a few issues which the government should focus on in the near future. Tax disputes, arising out of exemptions and incentives, due to claims and counter-claims lead to time consuming litigation process between tax administration and assessees. Sometimes, the ambiguity in tax laws lead to creative and different interpretations by the tax administration and tax payers.

So it is time to make laws clear, which gives minimum scope for tax litigation. Though the government has announced bringing down corporate tax rate from 30% to 25%, there is scope to make it much simpler by removing plethora of tax concessions, exemptions and surcharges. The government would v better off avoiding tax uncertainty like what happened in case of the Minimum Alternative Tax on Foreign Institutional Investors and General Anti-Avoidance Rule.

Also, it is time to remove retrospective taxation once and for all. Tax certainty and non-adversarial tax regime is a necessity for investors and is required for the government’s “Make in India” campaign. Strengthening institutions for early resolution of tax disputes will ensure predictable tax regime.

The government should also renegotiate with other countries like it has done with Mauritius for a phased withdrawal of capital gains tax exemptions without affecting investors.

(Sahoo is a professor at the Institute of Economic Growth, Delhi, and Garg is a researcher at the Indian Institute of Technology, Hyderabad)