The Goods and Services Tax (GST) came into effect in India on 1 July 2017. Even as it is too early to judge the performance of GST relative to the system of indirect taxation it has replaced, Gaurav Datt contends that there are a few aspects with respect to which it is possible to offer some evaluative comments.
The Goods and Services Tax (GST) came into effect in India on 1 July 2017. It had long been in the making – no less than 13 years since it was proposed by the Kelkar Task Force on Implementation of the Fiscal Responsibility and Budget Management (FRBM) Act in July 2004: ‘The major proposal of the Task Force is that the VAT (Value Added Tax) principle should be comprehensively used to tax the consumption of almost all goods and services in the economy’ (Government of India (GOI), 2004).
The Task Force proposed this as a ‘grand bargain’ within the Indian federal structure, whereby “both central and state government would exercise concurrent but independent jurisdiction over common or almost common tax bases extending over all goods and services, and in both cases, going up to the final consumer.” The grand bargain however took well over a decade to hammer out before the GST Bill, passed by both houses of the Parliament, received the President’s assent on 8 September 2016, and was enacted as the Constitution (101st Amendment) Act, 2016.
India has been a bit of a latecomer to the introduction of GST or VAT, which is now by far the most common form of indirect taxation around the world. In 2016, 166 countries were operating a VAT or GST (Organisation for Economic Co-operation and Development (OECD), 2016). While the US is the most notable exception, it would be fair to say that GST/VAT is the global norm for indirect taxation and an increasingly important source of government revenue for a growing number of countries.1
Even as it is too early to judge the performance of GST relative to the system of indirect taxation it has replaced, there are a few aspects with respect to which it is possible to offer some evaluative comments.
One tax, one market and efficiency of the tax system
In so far as it has subsumed a range of existing central and state indirect taxes and set up a common national tax base and framework for the taxation of goods and services by both levels of government, the GST has certainly moved the economy in the direction of establishing a more integrated national market. However, the ‘one tax’ part of the vision has remained elusive with the GST Council opting for a five-rate structure for GST, not to mention the threshold exemption and the composition scheme with a flat GST rate for small operators.2 The multiplicity of GST rates has come in for some criticism from several economists. Most countries operating GST/VAT systems around the world follow the practice of using one standard rate and one or two reduced rates including the zero rate for tax-exempt items. For India too, the Task Force on Good & Services Tax (Thirteenth Finance Commission) did recommend a standard rate of 12% (Finance Commission India, 2009). However, the GST Council has instead gone for a five tax-slab structure wherein it is difficult to define the notions of the standard GST rate and reduced rates.
Differential rates across the tax base have been driven by several considerations. First, there have been distributional or merit goods considerations, for example 28% tax on many luxury or ‘sin’ goods and zero rate on basic food items. This is done with a view to impart a degree of progressivity into the indirect tax system or to encourage (or discourage) consumption of merit (demerit) goods or goods with positive (negative) externalities. However, multiple tax rates come at a price (as discussed below). Besides, such social considerations are not the only reason for multiple rates. Another important factor has been to protect revenues for both the central and state governments. Thus, for instance, the vast majority of items are in the 18-28% brackets. Similarly, the reason why petroleum and alcohol products have stayed outside the ambit of GST is because they are important sources of revenue for the central and state government respectively. Another significant omission from the GST net is real estate, with sales of completed properties as well as leasing out of residential properties exempt from GST. Finally, besides outright exemptions, why certain items end up in a particular tax slab rather than another reflects a lot of political jostling within the GST Council reflecting often divergent political interests across states and between the Centre and the states.
However, a multiplicity of rates can create economic distortions, increase complexity of the tax system, raise administrative and compliance costs, and induce tax cascading effects. Multiple rates may induce further tax litigation by businesses around the applicable tax slabs for the particular products and services they supply or receive as inputs. It is also arguable that multiple rates may not be the best means of achieving distributional objectives which may be better served by measures directly benefitting the poorer sections of the population.
Expansion of the tax base
An ‘ideal’ GST has comprehensive coverage of almost all goods and services with a minimal list of exemptions. The GST provisions so far allow for (a) a significant list of exempt (zero-rated) items, and (b) a threshold exemption for businesses with an annual turnover of up to Rs. 2 million. By some estimates, the exempt items account for 30-40% of the CPI (Consumer Price Index) basket and nearly three-quarters of all non-farm enterprises are outside the GST net (GOI, 2018a).
Recently, the Central Board of Excise and Customs (CBEC) and the Economic Survey of India, 2017-18 presented some data based on GST registrations and returns since its inception in July 2017, indicating a substantial increase in the number of indirect taxpayers. As shown in Table 1, as of 1 January 2018, there were 9.9 million GST registrants, of which 6.4 million were old taxpayers migrating from the erstwhile central (excise and service Tax) and state (VAT) tax systems, while there were 3.5 million new GST registrants, leading the Economic Survey, 2017-18 to conclude that “the GST has increased the number of unique indirect taxpayers by more than 50 percent.” (GOI, 2018a). However, it would be incorrect to construe this as evidence for an expansion of the tax base, which ought to be measured not by the number of GST registrants or taxpayers but by the total value added that is subject to taxation.
Table 1. Number of GST registrants as of 1 January 2018 (in million)
Source: GOI (2018a, 2018b).
Other data also presented in the Economic Survey, 2017-18 show a highly skewed distribution of turnover and tax liability across firms (Table 2). Thus, 32% of GST returns are filed by firms below the exemption threshold (Rs. 2 million) and another 36% by firms with turnover below Rs. 10 million (eligible for the composition scheme). Taken together, these firms represent 68% of total returns filed. However, they account for only 3.8% of total turnover, and 5.3% of total tax liability. Since such smaller firms are likely to be over-represented amongst new GST registrants, the 50% increase in the number of tax registrants may not amount to much by way of an expansion of the GST tax base or tax liability.3 Thus, it remains to be seen how much of an expansion of the real tax base will result from the GST regime.
Table 2. Distribution of GST returns, turnover, and tax liability, by firm size (July-December 2017)
|Firm size (Annual Turnover)||% share in|
|Filed Returns||Turnover||Tax Liability|
|Below threshold (< Rs. 2 million)||32.2||0.4||0.9|
|Composition group (Rs. 2-10 million)||36||2.4||4.4|
|Small and micro enterprises (Rs. 10-50 million)||22||6.8||10.5|
|Medium enterprises (Rs. 50 million-1 billion)||9.2||24.1||29.8|
|Large firms (> Rs. 1 billion)||0.6||66.2||54.4|
Source: GOI (2018a).
Better tax compliance
It is expected that the GST regime will promote better tax compliance through a presumed reduction in compliance costs due to a simpler unified GST system replacing a number of central and state taxes, and better incentives for compliance. The Prime Minister described the GST as a “good and simple tax”. However, the system is not as simple as it may appear to be. A regular GST taxpayer is required to file 37 returns over the year (three returns – outward supplies, inward supplies, and consolidated – every month, in addition to an annual return), while a composition GST taxpayer is required to file one return every quarter. Invoice information needs to be uploaded to the system, and there are penalties for late submission of returns. The presumption is for an electronic filing of returns though manual paper filing has also been allowed. Compliance burden can thus be heavy, especially for smaller firms, and it is accentuated further by a continuing flurry of changes to GST design. The multiplicity of tax rates, exemptions, and parallel options of composition and regular GST can also be impediments to compliance as they increase the complexity of the system and open the door for tax litigation as well as evasion.
It is well-known that large scale under-reporting of sales was rampant under the earlier tax regime. The provision for availing input tax credit under the GST is intended to be an antidote to this practice. This may be helpful in case of B2B (business-to-business) supplies, but it is unclear how far it will incentivise better reporting of B2C (business-to-consumer) supplies. Thus, it remains to be seen how successful the new GST regime will be in improving overall tax compliance.
Higher tax revenues
An overall expectation from the introduction of GST is that it will yield higher government revenues from indirect taxation. Indeed, even the Kelkar Report of 2004 saw it as an instrument for revenue-led fiscal consolidation that will help raise the tax/GDP (gross domestic product) ratio. Revenue implications of GST are ultimately a function of three factors: (i) the size of the tax base, (ii) the GST rate structure and (iii) degree of tax compliance. In relation to the tax base and compliance – as discussed above – it is yet unclear how much of an improved performance will result from the GST regime. As for the rate structure, the Economic Survey, 2017-18 reported that the average weighted tax collection rate over the first few months of the implementation of GST was 15.6%, which was very similar to the revenue-neutral rate of 15-16% estimated in the ‘Report on Revenue Neutral Rate and the Structure of Rates for the Goods and Services Tax’ submitted to GOI in December 2015. Whether we will go past the revenue-neutral rate of collection is thus also something that remains to be seen.
In sum, therefore, given the inefficiencies and problems associated with the prevailing system of indirect taxation, most observers agree that the move to GST is a step in the right direction. That said, the inflated expectations from GST are not only premature but may also be unrealistic, as GST is unlikely to be the magic bullet to the country’s economic woes that the hype around this move has made it out to be.
There remain many challenges for effective implementation and several glitches to be fixed. For instance, a recent report documented how an accumulation of unpaid tax refunds has caused a serious liquidity crunch for exporters, threatening the survival of many in the tea and textile sectors. High compliance costs associated with the system of filing returns remain an important concern, especially for small operators. Frequent revisions to the rules and provisions – for instance, those relating to the reclassification of items across tax slabs, threshold exemption limits, and the filing of returns – by the GST Council and the Ministry of Finance have not helped. Despite a very long lead time, the eventual launch of GST seems to have come with inadequate preparation, which is difficult to simply pass off as ‘teething’ problems.
There are also significant challenges for the institutional mechanism of the GST Council as the grand Centre-states bargain. The Council is likely to emerge as a significant battle ground for fiscal federalism in India. While at one level, the many changes of policy details by the Council could be seen as just an expression of democratic practice in a federal system, the institution may also be hostage to all sorts of political lobbying by vested interests. How well it can ward off these dangers also remains to be seen.
- There were only about 50 countries with a VAT/GST in 1990, the number having more than tripled since (OECD, 2016).
- Threshold exemption is for businesses with an annual turnover of up to Rs. 2 million. The composition scheme is for small taxpayers with an annual turnover of up to Rs. 15 million (Rs. 7.5 million for special category states, (except Jammu & Kashmir and Uttarakhand), as specified in Article 279A of the Constitution) who can opt to pay GST at a flat rate (at 1-5% of the value of turnover) without input tax credits. Taxpayers opting for composition levy cannot collect any tax from their customers. The composition scheme is not available for inter-state supplies or for supply of services.
- The Economic Survey 2017-18 also reports direct estimates of the GST tax base of Rs. 65-70 trillion for 2017-18, but it is difficult to compare this with tax base of Rs. 65-70 trillion for 2017-18, but it is difficult to compare this with tax base of the earlier indirect tax system.
- Finance Commission India (2009), ‘Report of the Task Force on Goods & Services Tax’, Thirteenth Finance Commission, New Delhi, 15 December. Available at: http://www.prsindia.org/uploads/media/Constitution%20122nd/Report%20of%20Task%20Force-%20GST.pdf
- Government of India (2004), ‘Report of the Task Force on Implementation of the Fiscal Responsibility and Budget Management Act, 2003’, Ministry of Finance, New Delhi.
- Government of India (2015), ‘Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)’, 4 December.
- Government of India (2018a), ‘Economic Survey 2017-18: Volume I’, Department of Economic Affairs, Ministry of Finance.
- Government of India (2018b), ‘GST – Concepts and Status’, Central Board of Excise & Customs, Department of Revenue, Ministry of Finance.
- Mundy, S (2018), ‘India’s goods and services tax leaves exporters fuming’, The Financial Times, 15 January.
- OECD (2016), ‘Consumption Tax Trends 2016: VAT/GST and excise rates, trends and policy issues’, OECD Publishing, Paris.