GST is the tax system of the 21st century

Dr Arvind Virmani, former Chief Economic Advisor to the Government of India and the country´s representative to the IMF, says rollout of GST will help correct the bias against manufacturing. Terming it as positive for the infrastructure sector, he says that the full impact of the new tax regime will become evident over time.

What in your opinion are the key challenges that need to be addressed before the GST regime is formally rolled out early next year?
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. 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 1st, 2017. But the deadline should 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.

What are the vested interests that might come into play?
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 the 29 states, who knows where the vested interests are stronger and where they are weaker? I am sure that among the larger states, there are many vested interests. They generally have to do with poor governance and corruption. These are what we call ¨tax terrorism¨. One of the issues that have recently come up is what kind of registration and payments systems are you going to have. It is very clear that if you are setting up this whole electronic system of collection, it should be totally digitised.

What does that imply in structural terms is if we have a company 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.

The GST Council has 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?
There are specific challenges from my perspective as an economist who has worked on these issues for 15 years. 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, 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 minimise 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.

For 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 GST 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, petroleum is not inside it. So that has no relevance to the RNR which is going to be introduced from April 1st, 2017.

Having said that, what is generally in transition is useful to minimise 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 1st, 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 organisation 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.

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.

The second challenge is to focus on that higher rate and to be able to take that adjustment which will then have to happen to 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.

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.

The challenge is to make the people understand. Let´s say the existing service tax is 12 per cent, but the revenue neutral rate is taken as 18 per cent. In principle they would think of raising it by 6 per cent, but they are also getting an offset. So actually if you are paying 18 per cent to the government, you should not raise it by 6 per cent. You should in some case raise it only by 2 per cent to 4 per cent. 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.

Will the GST regime help in reducing production costs by eliminating the cascading nature of taxes on the infrastructure sector?
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 goods and taxable services, actually stand to benefit. The difficulty here is the third element. 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 does it come into the GST net?
There is the fourth challenge: how does that come into the GST net? Right now it´s kind of ambiguous.

As things stand, it´s not clear even in the existing system. 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.

There seems to be a clear division within the Indian Infrastructure Sector on GST´s service tax component. What is your own take?
There are two reasons why it is definitely positive. One is, having a single rate makes accounting very easy. 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. 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, is they don´t get this chain. Once the chain is there, then they will get the offsets also.

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 don´t understand. If the effective tax rates on goods, basically manufactured goods, go down and that on services go 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 per cent to 4 per cent, 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.

So how can India Inc gear up to take advantage of this new tax regime?
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 is 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 100 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 digitised 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 which 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 sensitised 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.