One tax to rule them all

Asuccession of finance ministers has industriously chipped away, for the last 20 years, on achieving a remarkable transformation of India’s tax system.

Vijay Kelkar | Print Edition: January 25, 2007

Asuccession of finance ministers has industriously chipped away, for the last 20 years, on achieving a remarkable transformation of India’s tax system. It is now increasingly clear that the most important challenge is the introduction of the Goods and Services Tax (GST). The benefits of the

GST are manifold. The introduction of the GST should be accompanied by a removal of almost all other existing taxes. Calculations show that this is fiscally feasible. There should be only three taxes in the country: the income tax, GST and
property tax. This will yield benefits because of the reduction in the number of tax collectors, associated compliance costs, economic distortions and harassment. Particularly important in the checklist for “bad” taxes that need to be removed are all taxes on turnover, such as the Securities Transaction Tax, the Stamp Duty, Registration Fees, octroi and many others.

The GST would induce a more fair treatment of goods versus services. Taxation should be a symmetric between consumption of a
good—such as a shirt—or a service, say telephony. With the GST, all goods and services would be treated in symmetric fashion, and thus reduce distortions.

The GST is related to customs reform. In the modern world, all countries operate on the principle that imported goods are charged GST at entry, but exports are refunded the full GST at the point of departure. This is only fair arrangement whereby local firms compete with imports on an equal footing, and local exporters compete with global exporters on an equal footing. Once this structure is in place, India can push forward on the endgame of customs reforms, that of eliminating customs altogether.

The most important benefit of the GST is that it would unleash India as a common market. Currently, goods do not easily move
across state boundaries within the country. Even though India is a giant economy with a GDP of over $800 billion, firms are often forced to operate within states, each of which might have a GDP of below $80 billion. The efficiencies of nationwide optimisation of storage and logistics are not obtained in key industries such as retailing. The GST would make it possible for firms to harness the economies of scale that befit a country of the sheer size of India, and to obtain remarkable efficiencies in logistics. This would translate to lower prices for customers.

The GST will remove the longstanding anti-manufacturing bias of the Indian tax system. Manufacturing in the modern world
involves a large number of operations, spread across many firms in many countries. India has not been able to achieve Chinese-style employment generation in manufacturing partly because of the burden of cascading taxes. The shift to GST will be good for manufacturing and thus employment growth.

In order to harness these benefits, Finance Minister Chidambaram has set a 2010 date for the introduction of the GST. The challenge is now about translating this intent into execution.

Indian democracy involves many actors, and has an exquisite dispersion of power. Complex fiscal reforms hence require special care in planning and implementation. An empowered committee for GST implementation now needs to be setup, emulating the successful fiscal reforms efforts for the fiscal responsibility and budget management and the state VAT. Unlike the state VAT, the GST involves both centre and states. Hence, it is fitting that this committee should be chaired by the Finance Minister.

There are four areas for action in the GST effort: establishing IT systems, building the central GST, the political effort of agreeing on a “grand bargain” and administrative efforts at the state level. The empowered committee needs to fight on all four fronts at once.

The first task is that of the IT systems. The Tax Information Network (TIN) system, built by NSDL, is the right foundation for implementing the GST. TIN already reaches 7,00,000 establishments, and these are exactly the establishments which need to be plugged into the GST. Hence, the IT development work should be initiated at NSDL now, so that we can be ready by April 2007.

The second task is that of consolidating Central Excise, the Central Service Tax and VAT on imports (i.e. CVD) into a single tax called the central GST. This needs to be announced in the Budget speech of February 2007 and become operational in April 2007, which dovetails with the time taken for IT implementation work connected with TIN. Over fiscal 2007-8, this system would go through debugging and incremental refinement, and the Finance Bill of February 2008 would introduce legal amendments that should put a closure on this task.

The next task is that of interacting with the states. On one hand, this is the political question about revenue sharing. The most fair formulation would place the entire GST collection into the hands of the Finance Commission for sharing with states. Calculations and fiscal scenarios must be made, and discussed with state finance ministers,in order to arrive at an agreement.

The most dangerous mistake which can derail this negotiation is a piecemeal allocation of certain services for taxation by the states. The fair deal that states should be offered is one where they tax all services, in return for their cooperation
in the administrative mechanisms for the GST, and remove all their own distortionary taxes.

The goal should be to complete these discussion and lawmaking efforts by December 2008. After this, the focus would shift to statelevel administration. At first, individual states should be merged into the TIN, one by one, at an administrative
level while keeping the state VAT distinct from the central GST.

Once major states are administratively working through the TIN, and the grand bargain has been agreed to, the stage would be set to throw a switch in April 2010, where India would become a common market with a single GST. Even if some states do not cooperate, it is feasible to start with an “Indian Common Market” of a few states, and gradually all the other states can join in.

(Vijay Kelkar is Chairman, IDFC-PECL and former adviser to Union Finance Minister)

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