Having made substantial progress in reforming governance and adapting Indian bureaucracy to his style of functioning, Modi has already got cracking on major economic reforms thereby silencing the critiques who alleged ‘big bang was missing’.
During the winter session of parliament commencing on November 24, 2014, the government has on top of its agenda a constitutional amendment bill on Goods and Services Tax (GST) – a revolutionary reform that was originally slated to come in to force in April, 2010 and has since missed several deadlines.
After considerable dilly dallying, the bill was introduced in the Lok Sabha in 2011 by erstwhile UPA government but lapsed with the dissolution of its 15th term. In less than 6 months of its assuming office, the present Modi-dispensation has moved on a fast trajectory and is now fully geared to take it up for consideration.
During several round of consultations with the empowered group of state finance ministers, Arun Jaitely finance minister, Govt of India has handled all contentious issues with diligence and dexterity and evolved a broad consensus – something that was missing during previous regime leading to protracted delays.
Considering the entrenched interests and substantial revenue implications of GST regime that will replace the extant dispensation, it was natural that states resisted changes that would infringe on their autonomy and freedom to garner more revenue. Yet, Jaitely has successfully navigated through rough terrains.
While, refusing to compromise on fundamental principles underlying the GST structure, he has also demonstrated in line with wishes of our prime minister, the much needed resilience to accommodate the concerns of all states – showing full respect to them consistent with federal character of our constitution.
The biggest concern of states was loss of revenue consequent to implementation of GST and they had a genuine worry on whether or not the central government would fully compensate for this. The apprehension was not without basis.
In the past, states that lost on account of reduction in central sales tax (CST) from extant 4% to 3% in 2007-08 and 2% in 2008-09 have not received full compensation amount till date. An amount of Rs 13,000 crores till 2010-11 is still pending. Modi-government has promised to clear this during current year.
For 2010-11, 2011-12 and 2012-13, erstwhile UPA government had decided to compensate affected states for loss of revenue @ 100%, 75% and 50% respectively. Apart from paying dues up to 2010-11, the responsibility for discharging obligations for subsequent years rests squarely on the present regime.
In this backdrop, it was only expected that states would go much beyond getting a commitment from executive authority at the center. Hence, they pitched their demand for compensation – consequent to GST – to be incorporated in constitutional amendment bill so that there is no room whatsoever for latter to back out. Jaitely has accepted this legitimate demand.
In the interest of realizing the full potential of GST, the states have agreed to subsume most of the local taxes (besides VAT) viz., entry tax, purchase tax, octroi, municipal taxes etc under GST. However, empowered group of finance ministers continue to insist on keeping land, alcohol, tobacco and petroleum products outside its ambit.
The central government may not object to keeping alcohol and tobacco out. However, it strongly believes that excluding petroleum products which are used in almost every segment of industry and services – akin to blood running through all parts of human body – will disturb the value chain and seriously undermine the effectiveness of GST in reducing the cascading effect of taxes.
Therefore, it has reiterated its stance – held all through – to keep petroleum products under GST. However, to accommodate sensitivities of states for now, it has proposed to keep these ‘zero’ rated and allow states to continue with existing dispensation of taxing them. This is intended to be a transitory arrangement and at an appropriate time, GST would be levied at desired rate and VAT abolished.
Jaitley may have done this to expedite a consensus and thus give a push to the bill for taking up in the winter session. But, this is dangerous territory as once he allows states to continue to collect tax on petroleum products outside GST framework, it may be difficult to bring them along in future. This will tantamount to a half baked reform that won’t yield optimum results. The centre must avoid this even if this means a bit of delay.
Government should insist on including petroleum products in GST structure at applicable rates for SGST (state-GST) and CGST (central-GST) right now. There should be no difficulty in making states agree to this especially when commitment to full compensation for revenue loss is being made as part of constitutional amendment bill.
The states are also being unnecessarily sticky in wanting a threshold (a level below which a business will be exempt from levy of GST) of Rs 1 million as against Rs 2.5 million proposed by center. The former’s position smacks of an antiquated mindset to bring as many traders within tax net no matter how small is their turnover.
Rs 1 million works out to just over Rs 80,000/- per month and is too small an amount to deserve levy of tax. The extra revenue collection by lowering threshold to this level won’t justify expansion of tax collection machinery and attendant cost. The states should agree to the very pragmatic proposal of center for keeping threshold at Rs 2.5 million.
A sub-committee of center and state government officials has recommended a revenue neutral rate (RNR) of 27% (13.91% SGST and 12.77% CGST). This is computed to protect revenue from indirect tax collections of centre and states in 2011-12. The rate is too high and does not exist anywhere in the world. The highest is 25% in some Scandinavian countries like Denmark and Sweden where there is high degree of compliance and enforcement system.
Even the 27% rate may go up depending on the outcome of a study commissioned to National Institute of Public Finance and Policy (NIPFP) to rework the numbers based on revenue collection figures for 2013-14. The high rate is clearly the result of excluding land, liquor and petroleum. According to a study, including these under GST alone would result in reduction in RNR by 5%.
Going forward, while NDA government has made the right moves and moved at good speed to ensure that GST is put in place by April 1, 2016 as promised, it needs to goad states to inculcate some resilience in their approach. The latter need think out-of-box more in tune with what the new structure promises instead of remaining glued to protecting their turf.
They need to focus on broadening the tax base by not just bringing more entities under tax net but also due to a boost to commerce and trade that GST will trigger. With this basic understanding, they must release the brakes by allowing land, liquor and petroleum to be included in GST design and agreeing to threshold of Rs 2.5 million.
To realize the full potential of this path breaking reform, states should get ready for GST of no more than 16% in conformity with practice globally. Given the big push to GDP that GST promises, they won’t be at revenue loss. Even so, center’s commitment to compensate them for loss if any – that too vide a constitutional obligation – should give them added comfort.
With the changes as suggested above, center and states should team up to ensure passage of GST bill in ensuing session of parliament followed by approval of 15 state assemblies next year for the new regime to be in place by April, 2016.