Q1: What in your opinion are the key challenges that need to be addressed before the GST regime is formally rolled out early next year?
A1: The most important thing is to view it as a historic opportunity. It is the first major economy related reform of the Constitution that has happened. It is also an opportunity to create a 21st century tax system. Of course, this is one part of the indirect tax system so we are really not touching the corporate or income tax. Let’s say even if you call it half or even two-third or three quarters of the tax system, there is an opportunity to put in place procedures, rules and administrative systems which we can be proud of. Now there is a bit of trade-off here because it has been decided to introduce it by April 01, 2017. This is a good thing in general. But my only fear is I hope the deadline will not override the first point I am making. Once you put in place the structure of tax collection, it becomes very difficult to change it because vested interest develops. So that in my view is the biggest challenge in the structural sense.
Q2: What are the vested interests that might come into play?
A2: Well the vested interests are already there because within the existing tax structures, which are going to be merged to form the new GST, you have 29 state tax administrations. I don’t think the vested interests at the central level are strong as the Prime Minister and the Finance Minister are sitting on top of them. And already the effort towards e-governance, Digital India and all the related things is pretty strong. So I don’t think there will be any problem in the Central Board of Excise and Customs (CBEC) etc. But out of 29 states, who knows where the vested interests are stronger and where they are weaker. But I am sure that among the larger states, there are many vested interests. And we know what these things are. They generally have to do with poor governance and corruption. So those are the vested interests or what we call “tax terrorism”. One of the issues directly related to this that has recently come up is what kind of registration and payments system are you going to have. Now it is very clear that if you are setting up this whole electronic system of collection, it should be totally digitized. What does that imply in structural terms is if we have a company ‘A’ which operates in ten different states, all that it needs to do is register once. That registration should automatically go to all those ten states. It should not be like in the old days where we had to register in every single of those ten states. The registration can always be updated and automatically sent to everyone concerned.
Q3: Following the very interesting observations that you have made, at the first meeting of the GST Council held on September 29, the Centre and states agreed to an exemption threshold of Rs20 lakh for all states, which has been set at Rs10 lakh in case of North Eastern states. The Council also adopted a cross-empowerment model for tax administration to compensate states and agreed to subsume all levies into the new tax. How do you see these developments?
A3: I gave the overall challenge, but there are specific challenges from my perspective as an economist who has worked on these issues for 15 years. And those have to do with two or three different things. One is the variation from uniformity. We talked about this broad rate. If you want to talk about the standard rate, or whatever else you may want to call it, and then there are exemptions on one side and higher rates on the other. The two challenges associated with this are always to make that standard rate as broad as possible and to minimize the two ends, so to say, the lower rate and higher rate. And the second one, which has been widely discussed in the media is to make it revenue-neutral. Now I find that a lot people are confused over the term revenue-neutral rate (RNR). Revenue-neutral always applies to things that this new tax is replacing. Just to give you an example, if liquor or petroleum is out of this system for the time being, revenue neutrality has nothing to do with that. So you are talking about the set of taxes which will go away when the GSTN is introduced from April next year and not what will happen in 2018, 2019 or 2020. That liquor part is not in the system so it’s totally irrelevant to this calculation. Similarly, as of today at least, the petroleum is not inside it. So that has no relevance to the RNR which is going to be introduced from April 01, 2017. Having said that, what is generally in transition is useful to minimize disruption. If you adopt that principle, it becomes very simple. The exemption part then is probably most efficient at this point at least as of April 01 to keep the things that are already exempt. They are two or three major ones. One is education and the other two are certain types of well-defined healthcare issues and certain government transactions. The government part I am not so sure as it is a big organization and it should be able to take it. So that government part is still an issue. I don’t know what the government and GST Council will decide. In my view, the government should pay the taxes and get the thing back as the money goes to them only. But they may decide to follow the principle that applies to private goods also to government. It’s understandable though one would prefer it to be changed. Currently, government-to-government transactions don’t pay taxes such as excise and stuff. Actually, in a proper system, all of that should be paid because you are getting the money and then you use it whatever way you want as against education and health which are private. The other issue I believe is sadly a self-created problem. I had actually recommended a uniform rate and about four or five sales taxes so that there is no higher rate. Why is higher rate a problem? Because if we collect the items that have the highest five rates they are all different. In my system that would have been easy. You take six items and to start with, you keep the same rates, with some adjustments. But now what they will have to do is make that uniform. Again, sad but feasible. The second challenge is to focus on that higher rate and to be able to take that adjustment which will then have to happen in the people who actually pay the taxes. And the third one is actually the trickiest because we are also integrating the service type of taxes with the goods type of taxes as part of this GST. And that’s actually the most difficult for the consumers so to say. What we know is that on an average the final sales tax is lower than the final goods tax. So when you have a uniform rate in the standard category, the average service tax will go up and the average goods tax will go down. But it’s not as simple as that. The goods people will also get input credit on services and service people will get all input on goods. So actually the real increase in services will be less than what appears to be so. And that’s a challenge. The challenge is to make the people understand, both the producers of the services that you are getting some rebate back so don’t charge in full. Let’s take a simple example. Let’s say the existing service tax is 12% but the revenue neutral rate is taken as 18%. In principle they would think of raising it by 6%, but they are also getting an offset. So actually if you are paying 18% to the government, you should not raise it by 6%. You should in some case raise it only by 2% to 4%. So this is the real challenge. And it really will have to be the government, industry bodies and service associations, which will have to educate producers of services who have to levy this so that they make a revenue neutral calculation. The idea of introducing is not for companies to make money but to put in place a revenue neutral rate, which over time is going to benefit everyone, including the producer, consumer and government. So these three are the specific challenges besides that overall thing which really concerns the centre and states.
Q4: Will the GST regime help in reducing production costs by eliminating cascading nature of taxes on the Infrastructure Sector?
A4: This question is easier to answer in generality than specifics. I will tell you why. All the things in the infrastructure sector which are specifically related to the good and taxable services, which we have just discussed, they actually stand to benefit. But the difficulty here is the third element. I had mentioned here certain goods like education, health and government-to-government transactions. But the construction part of the service sector is unclear. Who taxes it? What happens? To what extent it comes into the GST net? We took three challenges. This is the fourth challenge: how that comes into the GST net? But right now it’s kind of ambiguous. As things stand, it’s not clear even in the existing system. So that is where it could go either way. For some infrastructure sectors there could be a marginal increase, for others there could be effective decrease and for still others it may remain more or less the same. I don’t have any specific answer as of this point as we don’t know what will be the change on treatment of various construction services.
Q5: There seems to be a clear division within the Indian Infrastructure Sector on GST’s service tax component. While some have gone so far as to claim that it’s a negative aspect of the new tax regime others term it overall positive? What is your own take on this issue?
A5: There are two reasons why it is definitely positive. One is, as I indicated to you, having a single rate makes accounting very easy. That is why I told you, I would have preferred a single rate across the board, with a few sales taxes which separate out because the trail becomes very easy to follow. You just need two numbers: how much you bought and how much you sold, and the rate is the same. If you have three different rates, you are going to have three different channels and it becomes 3 X 3 = 9. So a single rate is actually a tremendous benefit, which is why I have long argued for it. Unfortunately, I lost the argument to my friend Vijay Kelkar who proposed this structure. It’s his committee report which is being followed. Why services benefit, as I said earlier, they don’t get this chain. Once the chain is there, then they will get the offsets also. That’s one. And it will make both export and import of services much smoother. The second reason is, in India, people have long complained that our economy is much more heavily service oriented than manufacturing oriented. What this will do is change that bias. And this is something that people are not understanding. If the effective tax rates on good, which is basically manufactured goods, goes down and services goes up, then the bias towards services will be corrected. People forget that and start complaining. They complain in one bucket and then in the other one they complain again. But these things are linked. If the tax on services goes up by as little as 2% to 4%, that’s a good thing because the structural bias towards services and against manufacturing will be corrected. This is something which people should focus on.
Q6: So how can India Inc. gear up to take advantage of this new tax regime?
A6: There are two types of people. One is those companies which are already operational across the system. If registration and other things are simplified in the manner which I have suggested, then what they will set up a much more efficient cross India structure to ultimately benefit consumers. Initially they will, of course, improve their efficiency and profitability, but over time with competition it is going to benefit consumers. Once that system is made clear by the government over the next six months, then there will be programs. It’s connected to what I said earlier. If there are hundred different rates it becomes very complicated. If you reduce it to three, including zero rate or whatever, the level of complexity goes down tremendously and it becomes easier to write these programs. You just need to enter in each requirement and everything will come out nicely. It’s a different issue for smaller firms. Initially those who are not digitized will face some difficulty, but then they stand to gain a lot in the long term. They have to make this effort now or get left out of the digital economy. The government has to communicate to them that it’s in their long term interest as the whole country and the world are going digital. There are firms who are operating on inter-state borders and for whom it was a huge effort to register in one state to other state. Let’s say you are on the Punjab-Haryana or Uttar Pradesh-Bihar border. For all such firms located on state borders it becomes easier to legally sell their goods across the border. I hope again that people are sensitized to this and the process of registration is made easy. I anticipate smaller firms, once the system is functioning smoothly, to gain significantly. And that’s good as we all keep talking about promoting small and medium sized enterprises.
This interview on the GST regime is published in the October 2016 issue of India’s premier B2B magazine Infrastructure Today.http://www.
Interview to Business Today on October 24, 2016
Q1: How much do you think the inflation worry is playing in the mind of the government as it decides on the GST rate? How inflationary do you think an 18% uniform GST rate would be?
A1: A revenue neutral is not inflationary at all. The inflationary concerns arise because some States are asking for much higher standard rate. The Union govt must be supported in resisting such pressure from States.
Q2: Would a four-slab GST regime be a disaster even if it is just a temporary arrangement? Do you think it would be a smooth transition to GST regime with a four-tier tax rate?
A2: The key gain from GST is the replacement of a dozen indirect taxes by I single debt. In the National VAT I had recommended there were exempted good as in GST and only one Standard rate for all other goods & services. However, I had recommended retention of few final consumer sales taxes (~6) on specific goods such as liquor, tobacco products, polluting fuels & 2-3 consumer goods like cars. This would have made monitoring of the tax set off chain much simpler.
The Proposed rates for GST are messier, but won't be anywhere near a disaster. There are always transition problems but I don't expect them to be surmountable given a positive attitude of tax bureaucracy.
Q3: Another issue is reaching consensus on compensation package especially when each state has already floated their loss figures? How much do you think the compensation package impact the central government's exchequer?
A3: Base for compensation has been agreed. Calculation of compensation shouldn't be a problem. The potential compensation will be calculable only after the rates & items are decided.
Q4: Do you think the idea of cess on certain goods under GST is central govt's way of ensuring that it does not face revenue shortage due to compensation to states?
A4: The center wants to impose a temporary cess to raise funds for compensation, to protect against the need for rate changes in near future. This will also ensure greater certainty for Union govt budget allocations/expenditures.