By R. Sekhar, Commissioner of Customs, Pune
Article
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. India’s
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 1990–91 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 Hon’ble 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. VATis 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 country’s 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 VATis the best form of general consump-tion 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 VATare a matter of concern. It may be inevitable to introduce some degree of explicit progressivity within the VATsystem 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 eST 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 Union’s 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 non-standard 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 eST by the year 2013. Countries that do not have VATare 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 eST 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 consideration of local conditions including support the level of the threshold limit above which firms . from trade and industry. Good GST design makes must register. One view is to set the threshold limit good VAT administration easier and bad design too high rather than too low. Dealing with a large makes good administration almost impossible. 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 VATdesign 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 Jegislativ,e 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. VATcan 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 stakeholders 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.
