This post, which is divided into three parts, will look at the implications of reforms such as UDAY and GST on state budgets. In this final part, we will take a closer look at the proposed implementation of the Goods and Services Tax. In the first part, we examined why it is important to look at this data as well as give an overview of the current trends in state budgets. Part 2 examined the UDAY scheme and its effect on state budgets.
The GST Bill proposes a national Value added Tax to be implemented in India which, if implemented, would completely overhaul the current indirect tax structure of the country. It is one of the flagship reforms of the current administration because it significantly simplifies and rationalises the current tax system, lowers the cost and ease of doing business and widens the tax base of the country.
Currently the central government collects excise duty on manufacturing, service tax on services and a central sales tax on intra-state sale of goods. In addition, state governments levy sales tax or value added tax on the sale of goods and many states levy an entry tax, such as Octroi, on the entry of goods in local areas. This has resulted in a very complicated indirect tax structure in the country with hidden costs for trade and industry.
For example, currently supply chains are designed to minimize the burden of the Central Sales Tax, with distribution centres located in individual States where the consumers are located. Because of such inefficient allocation of resources, there is lot wastage. A simplified system would enable companies to significantly optimise their logistics, distribution and warehouse capabilities leading to more profitable operations.
The GST proposes to subsume central indirect taxes like excise duty, service tax etc as well as state levies like value added tax, octroi, entry tax etc into a single consumption-based destination-centric tax. By simplifying several Central and State taxes into a single indirect tax, this reform would mitigate cascading or double taxation and would help create a common national market for goods and services. Furthermore, the simplicity of the new structure would help ensure easier tax enforcement and administration while broadening the existing tax base. In effect, consumers would see an overall reduction in tax burden while industry would be able to rationalise their cost of production making them more competitive.
The GST Bill requires a constitutional amendment meaning that it would have to be passed by both houses of parliament. The bill was passed in the Lok Sabha, but was held up in the Rajya Sabha due to objections raised by the opposition on a few issues. The key issues that need to be addressed pertain to the provision of one per cent additional tax on inter-state commerce which was designed to help manufacturing states, the proposed revenue neutral tax rate of GST and the composition of the GST Council – the body that would decide the rules and rates of the tax structure.
The proposed GST will have two components – Central GST (CGST) levied by the Centre and State GST (SGST) levied by the states. The centre would levy and collect GST on supplies in the course of inter-state trade or commerce. The tax collected would be divided between the Centre and the states in a manner to be provided by parliament, on the recommendations of the GST Council. States such as Maharashtra and Gujarat stand to lose a large proportion of their revenues to the centre on the implementation of GST because manufacturing forms a greater part of their local economies. The loss of revenue could wreck havoc on state finances because some of these states, like Maharashtra, have already run up significant fiscal deficits and as a result would not be able to allocate resources to help grow their economies.To compensate for losses arising from implementation of GST, an additional tax of up to 1% has been proposed to be levied by the Centre. The revenue from this tax is to be assigned to the origin states. This tax is proposed to be levied for initial two years or longer as recommended by the GST Council. Opponents of this additional levy however say that it runs counter to the very principle of GST and will deter creation of a national market by introducing supply inefficiencies and by favouring producer states over destination states.
The second issue relates to the actual revenue-neutral rate of taxation. In this regard the decision of the GST Council regarding exemptions (for example, on gold and precious metals, and area-based exemptions) will be critical as more the exemptions that are retained, the higher will be the standard rate. Even though ideally, there should be a one rate tax, currently a two-rate structure is envisaged with a standard rate varying between 17 and 18 per cent and a sin tax fixed around 40 per cent (for goods like luxury cars, aerated beverages, paan masala, and tobacco and tobacco products). Additionally, alcohol is to be exempted from GST which would raise the standard tax rate. The opposition party wants the rate to be written into the constitution amendment and capped at 18% however the government has taken a stand on not writing the explicit rate, and leaving it to the GST Council for implementation. In terms of state budgets, the issue is similar to the one for manufacturing vs consuming states, with certain states getting large revenues from sources like tobacco and alcohol. Even though it is better overall for all taxes to be subsumed into one GST, the states have concerns over loss of revenues to the centre.
The final issue is on the composition of the GST Council. The centre has proposed it be composed of two-thirds representation by the states and the rest by the centre. The opposition is of the view that the centres share should be reduced to one-fourth. The GST Council would be the body that decides when the additional 1 per cent manufacturing levy would be phased out, which taxes would go under exemption, what would be the revenue neutral rate and so on. States having a greater share in the GST Council would give them more control over how the GST would be implemented over the medium term, enabling them to plan their financials much better.
Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.