The collective sigh of relief over the passing of the Goods and Services Tax Bill (the 122nd Constitutional Amendment) by the Rajya Sabha today is a bit unreal. Far from assuming that we have crossed the biggest hump in its implementation, we must now gird up for a long, uphill climb to reap its benefits. The worst is yet to come.
The media-imagined reality about the Goods and Services Tax (GST) is overly rosy, if not plain wrong. The assumptions are questionable, the revenue math is probably wrong, and the benefits overblown in the short to medium term. Getting Congress and various regional party-led state governments to sign up for GST might have looked like the hard part, but, from a vantage point two years down the line, we will probably wonder how we were so sanguine.
Consider the expectations from GST. Last year, Finance Minister Arun Jaitley claimed while introducing the original GST bill that it would raise GDP by two percent. Where many countries implementing VAT (value-added tax) have observed a revenue buoyancy as the tax base is expanded, the effects of GST on GDP growth are not that noticeable.
The revenue bonanza, if it happens, may be achievable only over the medium term. If it was so obvious that revenues will zoom, the states would not be so insistent on being compensated for losses for five years, and the centre would not be so reluctant to give this unambiguous promise. This suggests that GST is an untested initiative, and it could bring negative surprises too.
A Business Standard calculation today shows that taxes on automobiles, logistics, FMCG and cement, among others, will come down. The question is this: if taxes come down in many sectors due to input tax setoffs (assuming 18 percent standard GST), any assumption that revenues will rise depends on a rise in sales volumes? Can this happen in the current atmosphere of economic weakness, where consumption is rising slowly?
From a vantage point two years down the line, we will probably wonder how we were so sanguine.
No one is also talking much about the short-term inflationary implications of GST. If the basic idea is to expand the tax base and bring everyone into the GST net, it automatically means that more taxes will be paid by more businesses, which will push up costs. Service taxes, in particular, will feed through directly to consumer prices, as seen in the recent rise in mobile, credit card, and utility services bills. One cannot rule out a one-time bump in cost-boosted inflation as the tax base is expanded. Expecting a cost rise to boost GDP is thus a difficult bit of logic to digest.
Then why are many states eagerly signing on the dotted line?
Three reasons. One is the consistent pink media hype that GST is the best thing after sliced bread. We are being carried away by a tide of unexplained optimism at a time of revenue pessimism.
The second is the push from a coalition of poor states, who think that since GST is a destination-based tax, they will benefit the most from it as they consumers more than producers. Barring three major manufacturing states--Gujarat, Maharashtra and Tamil Nadu--the rest think they will do well on GST.
The third reason is lobbying by big business, which will be the biggest beneficiary. Big business will find compliance easiest as it is already IT-savvy, and will gain from not having to deal with the current multiplicity of indirect taxes. When in force, GST will subsume 17 different central and state taxes, including excise, additional excise, service tax, additional customs duty, special additional customs duty, and various central cesses; at the state level, octroi, entry tax, state VAT, luxury tax, entertainment tax, and various state-level cesses will also be subsumed.
To be sure, there are no two opinions about the long-term gains from GST, which is a destination-based tax, and largely self-collecting since the purchaser of goods or services can deduct the taxes already paid by suppliers in previous stages. The purchaser has a vested interest in getting his suppliers to be GST compliant.
But there are many pain points to negotiate in the initial years, not least because there is almost no precedent of any federal country of India's size and complexity implementing a dual-control value-added tax (ie, the GST).
Consider how difficult things could be:
One, dual control on assessees with more than Rs1.5 crore of turnover. States have complete control over smaller businesses. While this could lead to double auditing by Centre and states on tax compliance, it may also leave small businesses at the complete mercy of corrupt state bureaucracy. And Centre and states could wrangle over bigger assessees when we still don't have clarity on a dispute resolution mechanism.
Two, over seven million assessees will have to be trained to file all their invoices and GST returns online. Most small businesses don't do this even now. The GST IT Network needs every document to be filed online, including all invoices.
Three, poor preparatory work. The work in preparing the state VAT bureaucracy to handle GST has not even begun in most states. All the focus has been on the legislation. There is at least one year of training and bug-fixing in IT to make this work smoothly. GST will not be in full bloom till at least mid-2018--just a year away from general elections.
The GST IT Network needs every document to be filed online, including all invoices.
Four, high complexity. A GST is beneficial if it is simple to administer, with few exemptions and exceptions. But in the Indian case, large parts of highly taxed goods--potable alcohol, petro-goods, and tobacco--are outside the GST, or inside it with a zero rating (meaning zero tax for now). There may also be three rates, a standard rate (which may be 18 percent), and a merit rate which will be lower, and a demerit rate, which could be as high as 35-40 percent. So in one integrated GST (central plus state GST) there will be two major items outside, and one inside with zero rates, and there will be many goods with lower and higher rates than the standard rate. In the Indian system, the tendency will be to keep tinkering with politically sensitive rates on goods of mass consumption.
Five, centre-state wrangling. Tussles about the actual level of compensation to states that claim a loss cannot be ruled out. There are already whispers that some states have begun to show high revenues, so that when GST kicks in, they can claim compensation. States are clearly trying to game the system, and there is nothing the centre can do when it is desperately keen to get the states to accept GST.
Six, fiscal deficit implications. If compensation rises to high levels in the initial phase of GST implementation, Arun Jaitley will have to tear up his fiscal consolidation roadmap. If anything goes wrong, he will get the blame. The states will claim they were pushed into it.
Seven, the subsumed taxes. There's a question-mark over how states will compensate local bodies or themselves for taxes that will be subsumed in GST. Among the taxes to be subsumed are Octroi and entry taxes, which go to municipal corporations. The Mumbai Municipal Corporation's Octroi collections annually are in the range of Rs7,000-8,000 crore. Will GST collections in Maharashtra be enough to finance this revenue loss? Entertainment tax losses will have to be made up by a higher state GST rate. This may have implications for the centre being able to retain the GST middle-rate at 18 percent. It is worth noting that the VAT average in the OECD (Organisation of Economic Cooperation and Development) is in the range of 19-22 percent.
Eight, the money trail. As a destination-based tax, GST is collected at every stage, with the latter stages setting off taxes paid in earlier stages. This means the entire tax cycle can be captured only when the consumer makes the final purchase. For example, if Manufacturer A sells a product to Wholesaler B for Rs100, he pays Rs10 as GST (assuming a 10 percent GST rate). Wholesaler B may then sell the product to Retailer C for Rs120, and pay only Rs2 as tax (Rs12 GST, minus Rs10 input taxes paid by Manufacturer A of Rs10). And when Retailer C sells his final product for Rs150, he pays Rs3 net as GST. The entire cycle of tax collections stops only with Retailer Y, and the full tax is collected at three stages: Rs10 from Manufacturer, Rs2 from Wholesaler, and Rs3 from Retailer. There is a lot of reconciling numbers at each stage in the tax collection process.
Nine, business supply chains. Even for the corporations that are rooting for GST, the new tax will involve a wholesale rethinking of supply chains and compliance procedures. It will not be a picnic, though they are obviously better placed to benefit from GST than their small business compatriots.
Jaitley will be hoping that he hits bull's eye. He needs luck to deliver.
Ten, there is the question of timing. The ideal time to implement a GST is when inflation is low, and growth is good. India's inflation rate is close to the upper tolerance limit of 6 percent, and GDP growth is being driven purely by consumption and government investment. There are also doubts over whether the GDP figure is real, given the new method of calculating it. In short, the economic conditions for the implementation of GST are not bright and sunny.
Even on the legislative front, there are hiccups. At least 15 states have to pass the constitutional amendment bill, and after that all 29 states and two Union territories have to pass their own GST bills. And the centre has to pass the actual GST bill and the interstate GST Bill to enable collection of the tax. There's a long wait for even this stage to pass.
Last, the GST rate faces a big hurdle: the Congress wants the rate capped at 18 percent, while no state thinks this will be enough. The Kerala Finance Minister told CNBC TV18 that 18 percent is not on. If the rate finally ends up at 20-22 percent, the estimates of short-term benefits of GST will have to be downsized. The Congress wants the GST rate to be presented as a non-money bill, which means the Congress can try to block the final rate in the Rajya Sabha. There is a lot of political scrimmage ahead.
GST is a shot in the dark. It may be a good tax to have in the long run, but in the long run politicians also have to worry about re-election. If GST causes heartburn, they will get cold feet. Jaitley will be hoping that he hits bull's eye. He needs luck to deliver.