The Hindu Business Line : Kelkar Task Force on Indirect Taxes

THE Kelkar Task Force on implementation of the Fiscal Responsibility and Budget Management (FRBM) Act has not received the attention it deserves, considering the importance of its proposals. While it was set up primarily to "fix annual targets, indicating the path of adjustment and required policy measures", it was also expected to draw up the medium-term framework for fiscal policies to achieve the FRBM objective.

The Task Force has, in fact, acted as a miniature Tax Reforms Commission, laying out the framework for a radical transformation of India's tax structure, both direct and indirect. I propose to touch on Kelkar Task Force's recommendations regarding the indirect taxes.

The baseline projections of the Task Force show that the country's fiscal stress will increase sizably, under the present tax regime. They show that the revenue deficit in 2008-09 will be 1.66 per cent of GDP and fiscal deficit will be 3.98 per cent. The gap of 1.66 per cent of GDP translates into Rs 51,540 crore. This is, indeed, a considerable challenge for the policy-makers.

The Kelkar Task Force, however, points out that in terms of percentage of GDP, such adjustments have been more than common in global experience, when we consider countries as varied, as Argentina, Brazil and Italy. The need for fiscal consolidation is, however, urgent and requires holistic actions on both direct and indirect taxes as well as expenditure.

The Task Force is of the view that fiscal consolidation should be revenue-led — accomplished by raising revenues more than by compressing expenditure. Increase of Central tax receipts also means higher receipts for States. Apart from this, the Task Force stresses what it calls "front loading" of tax reform — getting the tax reform accomplished earlier than later. This will help us guard against possible deterioration of macroeconomic situation, both globally and nationally.

In regard to indirect taxes, the Task Force proposes what it calls a "grand bargain" between the Centre and the States. The present structure of Central Excises and State imposed Sales Tax, including Central Sales Tax, will be substituted by a set up under which the Centre will levy a Goods and Services Tax, concurrently with the States.

The conditions of this grand bargain will be that the Centre and the State Governments would exercise concurrent, but independent, jurisdiction over common or almost common tax bases extending over all goods and services, going up to the final consumer. The Centre and the States would be required to set a limit to the number of tax rates at three ad valorem rates in addition to the zero rate. The rates will be as shown in the Table.

Under this proposal, the tax burden on most goods will work out to 20 per cent. The standard rate of 12 per cent at the Centre is lower than the Cenvat rate of 16 per cent. The States will gain access to taxing many services. The Centre and States are to agree on a commonality of exemption lists and threshold limits.

The treatment of exports and imports will be fully integrated in this dual GST system, with imports charged a two-part levy — representing the Central GST and State GST — exports are zero-rated obviously. This also requires the synchronization of administrative procedures and IT infrastructure. State VAT is expected to come within the existing deadline.

I afraid this is too ambitious a policy frame to be implemented within the coming nine months or so. First, the substitution of the existing excise legislation by a new GST legislation is a difficult task, given the heavy deadweight of existing judicial pronouncements on excise taxation.

Second, the State Governments may have their own revenue consideration. The Task Force has not stated whether it has consulted the State Governments in this regard.

The dynamics of tax reform has always challenged the ingenuity of political leadership. Central Sales Tax was the first attempt to rationalize the Indian Sales Tax system. It required a great deal of consultation with States. So did the substitution of sales tax on textiles, sugar and tobacco by additional Central Excises.

The Kelkar proposals, however, involve treading entirely new ground — although there has been much talk about it. It is important to ensure that the Finance Ministry initiates a process of consultation with the States before passing judgment on an ambitious grand bargain!

The lesson of experience is that an existing tax is like an old shoe. If it pinches, one knows what to do. A new tax — even a new name for an old tax — creates new afflictions both imaginary and real. At least, for reasons of hurt ego, State Governments may not readily agree to giving up their current domain of freedom to vary rates and exemptions. The least that Government has to do is to negotiate the details of the Kelkar proposals with State representatives, in all its details.

Suppose this effort leads to a successful conclusion. Even so, the integration of administration of the proposed GST at the Central and State levels will be a tremendous challenge for the technocrats, who devise the IT solution. Kelkar has reposed confidence in the emerging income tax intelligence network to ensure that tax evasions are reduced in the indirect tax system also.

One hopes that the actual experience in the field bears out this estimate of seamless adjustment. Too many adjustments at one time are a recipe for problems. The GST introduction coming on top of VAT could be a difficult exercise to complete successfully. Kelkar has been driven primarily by the realization that under the current structure, excise has not been buoyant.

I would personally have preferred a step-wise approach, first the introduction of VAT on the existing Cenvat basis plus services tax and then substitution of the excise tax structure by a General Sales Tax on goods and services. But, the experts have a different view. I hope they are right.

The reformers have to note that while everyone is gung-ho on the prospects of VAT, there are a few discordant voices, including Mr Mukhopadyaya, former member, Central Board of Excise and Customs (CBEC), who has pointed out in his various writings that experience with VAT in many countries has not been that encouraging. He has recently cited an IMF study to that effect.

It is perhaps too late in the day to reverse the VAT procession. But it is important to realize the dangers, anticipate the difficulties that are implicit in VAT-led evasion and prepare for them even as we accept the latest grand bargain. The argument I make is not against change, but against rushing through grand visions and bargains, lest they become Faustian. Hopefully, the Finance Minister is only too aware of the risks of embracing nostrums of instant tax reform.

An important modification in the new tax structure referred to incidentally by Kelkar is the abolition of stamp duty on real estate transactions and substitution by a VAT-ted GST on them. This does involve a considerable diminution of the scope for abuse, especially in regard to stamps and dealings therein.

At the same time, the possibility of VAT-ting real estate transactions in respect of those who rent the buildings is complex, since those who rent do not pay excise duties or Sales Taxes and cannot claim VAT. This requires a level of compliance on the part of builders as well as hirers, especially in respect of huge building structures.

Whether such a tax is levied in any countries with success has not been stated in the report. If it were, the experience does deserve study. But, this is yet another difficult part of the Kelkar report, which will raise eyebrows in many State Governments, which derive substantial revenue and patronage from the administration of stamp duties.

That there is need for tax reform is not in question. But, tax reform is not only in the heads and hearts of experts. They also involve the tax-payers — the corporates, the small trader, and above all, the consumer. They also bring in the politicians, who may see the new proposals as tax imposition in another name.

It is important to educate the politicians on the Kelkar proposals, which may not be as bad as they may appear at first sight.

Tax reform is a difficult challenge at the best of times. All the more is it so in these days of fractious politics and of consensus with coalition partners. The fact that many States have to agree to the grand bargain proposed by Kelkar is all the more of a problem, in that the proposal may appear to dilute State powers.

It will need all the political wisdom of the leaders of the present Government to bring about a reasoned consensus. The question remains. "Is the effort worth all the bother? Can we not solve the problem in a simpler and less grand manner?"