Posted in Finance Articles, Total Reads: 4522
, Published on 12 November 2015
Much has been already said about the implementation of the Goods and Services Tax (GST) in India and its possible implications on the status quo. This article is an attempt at evaluating the economic impact of redesigning the existing tax structure and moving on to GST that looks to replace all indirect taxes with a single tax rate as a means to simplifying the tax levying process for the Indian government. The central idea behind GST is to shift the tax mix from income based to consumption based.
The present structure of taxation entails the levy of a number of indirect taxes on businesses and individuals. These include the following:
(i) Central Excise Duty
(ii) Service Tax
(iii) Sales Tax
(iv) Value Added Tax
(v) Securities Transaction Tax
A number of problems arise in this, primarily that of double taxation on the producers and manufacturers and the consequent tax evasion techniques employed by them to escape paying out hefty amounts of their profits to the government. The result: A considerable decline in the tax revenues for the government and a less-than-optimal production of goods in an economy.
A GST tax, however, stands to eliminate the above through a single tax aimed at establishing a national market. Approximately 140 countries around the globe already have a GST tax structure that ranges anywhere between 15 per cent – 20 per cent, and are deriving benefits from it, at government, corporate as well as consumer level. It will involve taxation in three forms:
(i) CGST: Applicable for inter-state sale of goods and provision of services
(ii) SGST: This form would be applicable for intra-state sale of goods
(iii) IGST: The centre would levy IGST which would be the sum of CGST and SGST on all inter-state transactions of taxable goods and services with appropriate provisions for consignment or stock transfer of goods and services, in case applicable.
A comparison of existing tax system and GST
A very important implication of GST is that it would reduce tax burden on producers and foster growth through more production. Manufacturing is a costly business under the current taxation system where a producer has to pay taxes not only on raw material procurement, but also on the final receipts from sale of goods. This double taxation prevents manufacturers from producing to their optimum capacity and retards growth. GST, on the other hand, would take care of this problem by providing tax credit to the manufacturer. Basically, the tax already paid by him will be deducted from his final sale tax receipts and he would only have to pay the difference, i.e. for the value added to the product by him. Also, due to absence of tax credits applicability for interstate transactions, a manufacturer producing in one state has to pay taxes on sale of those goods in other states as well. This adds to their cost and leads to lower productivity. The various tax barriers such as check posts and toll plazas lead to a lot of wastage for perishable items being transported, a loss that translated into major costs through higher need of buffer stocks and warehousing costs as well. A single taxation system could eliminate this roadblock for them.
A single taxation on producers would also translate into a lower final selling price for the consumer. Currently, for a customer, the tax burden of goods in anywhere between 25-30 per cent while GST proposes a tax rate of 18 per cent in the first year of implementation and would be brought down over the second year and in later years. The consumer would not only be able to purchase more goods with the same amount of money, he would also look to buy more, thereby spurring market demand. Also, there will be more transparency in the system as the customers would know exactly how much taxes they are being charged and on what base.
GST would add to government revenues by widening the tax base. Until now, services had been exempted from taxes. GST, however, brings them under the purview of taxation as well. This would eliminate tax evasion by corporations that escape taxes by bundling their goods along with services or whose products fall on the borderline of a good and a service, such as software products. Also, GST provides credits for the taxes paid by producers earlier in the goods/services chain. This would encourage these producers to buy raw material from different registered dealers. This would bring in more and more vendors and suppliers under the purview of taxation and reduce the ambiguity of the existing unorganised sector. According to the National Council of Applied Economic Research study conducted in 2009, the GST could provide gains in India’s GDP in a range of 0.9 to 1.7 per cent over the years starting from its implementation, assuming the revenue-neutral rate to be anywhere in the range of 6.2 and 9.4 per cent. The revenue neutral rate is the net difference in the overall collection of centre and states (the idea is that if implemented, GST could lead to tax revenue losses in some states. In such a situation, the central government would be compensating them for the same for the next 5 years). Additionally, GST is also expected to exclude state excise on alcohol and tobacco from its purview. This implies that a large revenue source still rests with the state government to generate cash flows from.
Current Macroeconomic Indicators of India
Source: Trading Economics
GST also removes the custom duties applicable on exports. This has major implications for the Indian economy: making exports tax-free would spur trade for our economy. Our competitiveness in foreign markets would increase on account of lower cost of transaction while the imports will be taxed same as domestic goods and services. If we look at the simple aggregate demand equation of macroeconomic theory:
AD = C+ I + G + (X-M)
Where AD = Aggregate demand in the economy
C = Consumption demand in an economy
I = Investment demand in an economy
G =Government’s spending on goods in an economy
X = Exports by a nation
M = Imports by a nation
On account of GST, the exports and imports are expected to increase by 3.2 – 6.3 per cent and 2.4 – 4.7 per cent respectively (source: aforementioned NCAER report). This would add to the aggregate demand for goods in our economy. With unutilized capacity existent in India, this would foster growth by encouraging production.
The concept of GST is more streamlined towards a longer – term perspective but does involve some short – term challenges which will have to be overcome, such as that of the administrative costs that would have to be borne in coming up with an administrative system for GST and for working out the transitional agreements. Additionally, the tax proposal still faces opposition from states who are unwilling to give up control on their tax revenue sources. Given the different tax structure prevalent in all states, the negotiations over GST seem to hit a roadblock every time over the transition of the local tax system so as to integrate it with a national one. However, once implemented, the system holds great promise in terms of bolstering growth for the India economy while bringing it more in line with the tax system followed internationally.
This article has been authored by Preksha from MDI Gurgaon
Ten things to know about the GST Bill – The Hindu
National Council of Applied Economic Research study, 2009
Rajya Sabha panel endorses majority provisions of GST Bill – The Hindu
A comparison of existing tax system and GST
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