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Total Number of Subscribers: 467 |
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Date:7th January 2009 |
Compiled by Mr. M. Sathya Kumar |
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GST Issues and Policies Government without treasury is unknown in history. Government
raises revenue mainly through taxation or borrowing. Taxes matter both for
the government and the governed. We all know we need to pay taxes for public
services, but still most of us complain about taxes and avoid them, if
possible. 2. Tax policy, its design and tax administration are the
reflection of the economic reality and the social and cultural factors of the
society. Tax policy of a country is shaped by ideas and interest, global
economic reality, administrative constraints, political institutions and
technological developments. A tax policy needs to delicately balance the
objectives of revenue, the need to facilitate economic growth and stability
and equity. Political economy necessitates balancing of growth and equity.
Though there is no alternative to growth, growth without equity is neither
desirable nor sustainable. A policy oriented towards growth cannot,
therefore, ignore the need to put in place measures to protect and ensure the
welfare of the weak and vulnerable sections of the population. 3. Evolving a tax policy and designing a tax system for a fast
developing and increasingly open economy is more challenging. Indias international trade-to-GDP ratio exceeded 35%. The task
becomes
complex in view of internationalisation of economic activities arising from
globalisation and liberalisation. Lowering the level of protection available
to domestic manufacturers of goods by reduction of customs tariffs, entering
into free trade agreements, both bilateral and multilateral, and
liberalisation of international trade have direct bearing on the
competitiveness of the domestic industry and thereby their very survival.
These developments necessitate the need to tune the tax policy in line with the
changing economic environment without loss of time. Tax reform in a
globalised world has become a necessity for survival rather than a matter of
choice. The nation took a conscious decision to embark on the path of
fundamental tax reforms. 4. Indirect tax policy and system in India has been undergoing
fundamental changes. It is a well-accepted thinking that high tax rates do
not necessarily result into higher revenue, but are likely to discourage
compliance and distort economic activities. High tax rates may not also seem
to be an effective method to distribute income and wealth. Peak basic rate of
customs duty on manufactured non-agricultural products was reduced from more
than 300% in 199091 to 10% in 2007-08. During the same period, ad
valorem basic excise duty was also reduced from 110% to the CENVAT rate
of 14%. 5. The process of globalisation making competitiveness a global
issue and not a country-specific issue made many countries to reduce the
direct tax rates, both on corporates and persons, and customs tariffs and
simultaneously increase their reliance on domestic consumption taxes. In many
countries and regions, there is a shift from direct to indirect taxes.
Globalisation led to significant reduction in customs tariffs and consequent
reduction in reliance from customs revenue. During the period 1990-91 to
2007-2008, customs revenue has grown only by 404% as against 607% growth in
domestic consumption tax revenue. Ensuring the competitiveness of the tax
system is an inevitable response to the broader picture of global economic
integration resulting into global competition. 6. The Honble Finance Minister in his Budget
speech
2006 stated the intention to move towards comprehensive goods and service tax
(GST) by April, 2010. The scope of the Empowered Committee of State Finance
Ministers (ECFM) has been expanded to deal with issues relating to GST. The
institution of Empowered Committee of State Finance Ministers is one of the
most successful innovations in fiscal federalism. GST is considered to be the
single largest tax reform of the country in the domestic taxation. Adoption
of Value Added Tax (VAT) at the Central level and also by all the States for
taxation of goods and services has given enough confidence to all the
stake-holders to move towards GST at the national level. 7. Major problem afflicting taxation of goods and services today
is the tax cascading arising on account of the partial nature of the taxes
and also of multiple and overlapping taxes. Current tax structure results
into varying degree of taxes on goods and services depending upon the nature
of inputs used. No credit is allowed on CST paid on interstate sales. Even if
the statutory rate is the same, effective tax rate varies from product to
product, depending upon the quantum of hidden taxes paid on inputs and the
structure of production and distribution chain. 8. Indirect taxation in India, therefore, provides opportunities
for planning and arbitration. Simplified system of taxation reduces the cost
of compliance and cost of collection considerably and would enable the
business to plan its activities. GST reduces the scope for ad hoc decisions
and political compromises apart from reducing the compliance cost. 9. The core objective of GST is to remove barriers for trade by
creating a common national-level domestic market. A major reform of such
magnitude does require change of ideas, attitudes and mind-sets. This may
cause discomfort mainly on account of fear of the unknown. If one appreciates
the economic advantage of GST and appreciates its necessity in the context of
the global economic competition, then apprehensions and misgivings may not
have any place. 10. Consumption tax on goods and services on the basis of value
addition known as VAT or GST has been emerging as the tax of the future. The
global experiences support that VAT is the most effective mechanism to raise
revenue efficiently. The fact that more than 145 countries in the world
across the ideological spectrum adopted VAT to tax domestic consumption of
goods and services substantiates the view that VAT has now become a main
feature of indirect revenue system. 11. GST or VAT is a broad-based tax levied on multiple stages of
production and distribution with the taxes on inputs credited against taxes
on output. Revenue is secured by being collected throughout the process of
economic transactions, but without distorting production decisions. It is
collected at each stage of the transaction and the amount of tax is
calculated on the prices of the goods and services at the rate applicable
after deduction of the amount of VAT borne directly on various inputs used
for providing output goods or services. Taxes collected at intermediate
stages are only pass-through transactions. Collection of tax being at each
stage of the transactions with input credit scheme, VAT has inherent
incentive for tax compliance. Being a consumption tax imposed on goods and
services, the tax burden is to be borne by ultimate consumers. 12. VAT is the single
largest source of revenue in some countries and one of the most important
sources in many more. Increase in VAT collection is not at the expense of
income tax. VAT and income tax are in fact complementary to each other and
one is not a substitute for other. VAT is a simple way of collecting sales
tax. No fiscal innovation is ever spread so widely in such a wide variety of
countries. 13. GST designed with the objective of economic efficiency and
neutrality requires : Harmonisation of tax base, tax
rates, tax laws and procedures. To avoid cascading effect by providing
credit of total amount of tax paid on inputs. To levy tax on destination basis. To ensure uniformity in law and procedure. 14. The relevant questions to be responded while designing GST
are, Whether GST can address the
fiscal tasks imposed by trade liberalisations and other economic factors ? Whether a single GST in a federal
country would affect the political equilibrium reflected in the countrys fiscal structures ? Whether GST addresses the concern
of vertical equity ? Equity and distributional effects of GST are matters of concern
and academic debate. It is difficult to design VAT to meet the needs of
vertical equity. However, experiences all over the world show that at present
VAT is the best form of general consumption tax available. 15. One of the critical areas in designing single GST is
sub-national jurisdiction in levying of VAT. GST design in a federal country
needs to take into account : the fiscal autonomy of provinces; to use tax as an instrument to
achieve
social or economic objectives; and risk and rewards of ownership of
the
tax. 16. Considering the revenue needs of provinces to meet their
developmental objectives, provinces do expect sufficient fiscal space to
mobilise revenue. The Constitution of India clearly demarcates the taxation
power between the Centre and the States. GST model needs to strike a balance
between harmonisation which is critical for economic efficiency and creation
of common domestic market and fiscal autonomy of the Centre and the States
required to discharge their obligations. 17. Though the desirable objective is broader base with lower
rate, preferably single rate, the need to protect and ensure the interest of
the economically weaker sections by way of exemptions, reduced rates or zero
rates for basic services like food, medicines cannot be totally ignored
especially in a developing or transitional economy. Equity aspects of VAT are
a matter of concern. It may be inevitable to introduce some degree of
explicit progressivity within the VAT system itself. In such cases, reduced
rate is generally considered as the preferred choice. Minimising distortion
and at the same time accommodating the different economic and social
objectives is the real challenge for designing the GST system. However,
experiences show that introducing specific measures inevitably creates
complexities and resultant cost and goes contrary to the demand for
simplification. It is also a challenge to balance the procedural requirements
to eliminate the possibility of non-compliance and fraud and at the same time
ensuring that the level of compliance cost does not affect the ability to
compete. Ideal model may not be politically acceptable and administratively
feasible. 18. Different forms of GST exist in different countries. What is
important is designing an appropriate GST to suit the specific needs and
environment and then running it efficiently. Differences among various GST
systems indicate the objective reality of history and politics of member
countries. European Unions VAT is the much talked about VAT.
However, there is a strong view that the Sixth VAT Directives of EU need
major revision to cope with the realities of the expanded, more integrated
and more developed EU of today. 19. The single-rate structure usually considered as an ideal and
recommended by experts is followed only by Denmark among the EU countries.
Most EU countries have a standard rate with two reduced rates. The average
effective VAT rate as compared with the standard rate among EU member states
varies widely and the percentage of variation is in the range of 8% to 32% of
the standard rate. In EU, about one-third of the tax base is subject to
nonstandard rates including zero rate. Exemptions also vary widely from
country to country. VAT in EU differs on many important aspects. Variations
are in relation to the tax base, treatment of foreign trade-origin or
destination, and the method of collection. 20. GST model followed by New Zealand, Singapore and Australia
with broad base and single rate is no doubt a clean model. But it may be
difficult to replicate such model in a federal structure with strong identity
of units and also in developing or transitional economies. 21. Despite differences, almost all the VAT models in the world
follow the principle to tax consumption on destination basis and is applied
on a transaction basis using the invoice credit
(output tax minus input tax) method basis. Origin-based income type VAT
exists in Italy, Japan and some American states. China already initiated the
process to have GST by the year 2013. Countries that do not have VAT are US,
Iraq, Iran, Cuba, some oil-rich countries and large number of small island
countries basically in the Caribbean and Pacific. 22. Selectivity and discretion erode tax base and tend to create
powerful special interest groups apart from introducing complexity in the
system. Single national-level GST does avoid issues relating to interstate
transactions. However in a democratic polity with federal structure and
assignment of tax powers, it may be difficult to achieve, if not impossible,
the ideal comprehensive value added consumption tax at the national level.
The other model is taxing consumption at uniform rates across goods and
services. This will avoid tax-induced distortions, bring simplicity and
minimise the pressures for favourable treatment for some goods or services
over others. However, fiscal autonomy warrants power to decide the tax rates
to meet the revenue needs notwithstanding harmonisation of law and procedure. 23. Independent VAT applied simultaneously on the same tax base
by two different and overlapping jurisdictions leads to high administrative
and compliance cost. The only way in which sub-national units can effectively
levy VAT is on origin basis. In such cases, if the rates are not uniform,
results would be highly distortionary. 24. Destination-based consumption VAT through invoice-credit
method requires physical border controls. In the absence of border controls,
the alternative approach is to put through some form of clearing house
mechanism to deal with the state transactions. Considering the magnitude of
transactions, this approach requires a sound and extensive IT infrastructure. 25. One of the most critical VAT design issues is the level of
the threshold limit above which firms must register. One view is to set the
threshold limit too high rather than too low. Dealing with a large number of
very small taxpayers inevitably results in some loss in administrative
efficiency. It is preferable to include all firms above a fairly high
threshold in the tax base. The other view is that high threshold limit
reduces the tax base and encourages growth of informal sector. A balanced and
a pragmatic view needs to be taken. There are also challenges to make GST
work in a system, which relies on self-assessment. 26. Desirable features of VAT design such as single rate, zero
rating instead of exemptions, refund of input tax credit, that cannot be
adjusted against taxes due on outputs may not necessarily be feasible in the
context of the economic realities. Features like more than one rate, few
exemptions, and too high or too low thresholds may be inevitable at a
particular point of time for successful adoption in the first place. However,
experiences show that it is extremely difficult to remove such features at a
later stage. 27. The clean system is critical in lowering compliance cost for
business and administration cost for Government. The fundamental choice is
between concessions to some with high rates or no concessions with low tax
rates. This needs to be explained and communicated well so as to evolve a
consensus. 28. VAT provides a competitive advantage to the country that
implements it. It removes hidden taxes on exports. Many goods and services
that bore no taxes are in fact have hidden taxes paid on most of their
inputs. The resulting pattern of effective rates on products and industry
vary widely and bear little relation to the legislative intent. In India, the
study shows that the tax incidence on different commodity groups varies
widely. Elimination of exemptions and concessions reduces administrative cost
as well as the influence of special interest groups on tax policy.
Self-imposing nature of GST leads to increase in revenue productivity. VAT
also strengthens the information base of the tax administration, resulting in
improved compliance not only of VAT, but also of other taxes. 29. Critical factors for successful implementation of GST are
political commitment, adequate and advance preparation, investment in tax
administration, extensive public education programme and consideration of
local conditions including support from trade and industry. Good GST design
makes good VAT administration easier and bad design makes good administration
almost impossible. 30. "Tax Administration is Tax Policy" says Milka
Casanegra. The real tax system is that which is administered, not that which
appears in the formal law. VAT can certainly be designed to fit into the tax
administration of the country. 31. The most basic lesson learnt from international experiences
in implementing GST is that doing it right is in most respects a matter more
of art than of science. It is extremely critical to keep the administrative
dimensions at the Centre rather than at the periphery while designing the GST
system. Poor administrative system creates a wedge between theory and
practice and thus encourages the spread of informal economy. A good policy is
only as good as it is administered. It is important to keep in mind the
administrative realities. Reform of the tax system is not a one-time affair.
It is a dynamic process in which the responses are to be calibrated
continuously. 32. Successful implementation of GST requires an effective
consultative and communication process. Consultative process helps to improve
the quality of decision-making. It may not be possible to have consensus with
many interest groups and the public on all issues. As long as the decisions
are fair and reasonable, and consistent with the stated core objectives,
consensus develops after the decisions deliver satisfactory results. It is
equally important to appropriately package the proposal. 33. There are no disagreements between the Centre and the States
and trade and industry on the issue of common tax base, rates and laws and
procedures. The issues are more on details and the mechanism required to
achieve the stated objectives. Considering the consensus and the enthusiasm
of the stake-holders and the appreciation of the necessity and economic
benefits of GST, there is every reason to believe that the country is on the
right path and will reach its destination. Article
by R. Sekar , Commissioner of Customs . The Article earlier
appeared in the Bombay Chartered Accountants Society |
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