GST- the single most important tax reform in India

Dated 23rd November, 2014

Union finance minister Arun Jaitley recently said that the draft legislation to enact the long pending goods and services tax (GST) is almost ready. He stressed that the passage of GST is among the three most important targets for the National Democratic Alliance (NDA) government in the winter session of Parliament. Even at the earliest, GST is expected to roll out in April 2016, six years after its scheduled start.

When enacted, GST is expected to broaden the tax base, improve export competitiveness by removing several tax distortions from the Indian economy and create a seamless national market by removing inter-state barriers to trade. The resulting ease of doing business is expected to boost national income by as much as two percentage points.

Despite a consensus among all political parties on the importance of adopting GST, which is the single most important indirect tax reform in India, the Manmohan Singh government failed to build consensus on GST when it came to the details of implementation.

The NDA government, too, has had to tackle some very similar issues since it came to power in May.

The trouble is that the enactment of GST will obviate the discretion of state governments in imposing several indirect taxes such as octroi. As matters stand, GST will affect the revenue of each state differently and many states have quibbled over details of GST just to ensure that they are not worse off after it is rolled out.

Thus, revenue compensation has been at the heart of all negotiations between the Union and state governments, be they over the rate of state GST and central GST or the list of goods and services, such as liquor, exempted from it. If these frictions were not enough, the United Progressive Alliance (UPA) government decided to backtrack on adequately compensating the states for the reduction in the central sales tax from 4% to 2% in 2007 in a move targeted towards the introduction of GST in 2010. As of 2010, the Union government owed Rs.13,000 crore to the states by way of compensation. Moreover, apart from the technical details, the states have asked for compensation for five years instead of three after the introduction of GST.

Reports suggest that even now, when there is consensus on almost every other detail, there still exist differences over whether GST’s threshold limit should include businesses with annual turnover of Rs.10 lakh per annum or Rs.25 lakh. The states, again for the purposes of shoring up more revenues, want to tax businesses as small as ones with an annual turnover of Rs.10 lakh while the Union government wants a higher limit of Rs.25 lakh.

The Union government’s argument is that states collect just 2% of their revenue from small businesses while 60% of the small businesses fall in the intermediate range. Having a higher threshold will have a salutary effect on small business activity without any dent on overall revenue collection. The underlying issue is the same—the level of compensation to the states.

But is it not just the states that are concerned about their balance sheets. The Union government, too, is worried about meeting its fiscal deficit target. Making matters more uncertain are recommendations of the 14th Finance Commission, which is scheduled to give its report by December-end. The recommendations of this panel may further tie up the Union government’s hands by asking it to devolve a greater percentage of the overall tax kitty to the states.

The stalemate calls for an innovative solution. And the answer, as it were, is blowing in the wind. The Union government has plenty of resources to compensate the states. Consider Air India.

The airline has been a drain on the exchequer for a long time. It is, in fact, the best example of why governments should not be in the business of running businesses. Every few years, the taxpayers end up bankrolling Air India. In April 2012, the Union government had approved a Rs.30,000 crore package to rescue the airline which is now expected to post a turnaround not before 2021. As of 30 September, Air India had a total debt of Rs.40,000 crore. It is expected to post a loss of Rs.3,900 crore for the last fiscal. This comes on the back of a loss of Rs.5,100 crore in 2012-13 and a loss of Rs.7,100 crore in 2011-12.

It is time for the government to put its money where its mouth is. It should sell off Air India and use the proceeds to abundantly compensate state governments to ensure the smooth and speedy enactment of a fundamental tax reform in independent India.