The Hindu Business Line : Pitfalls in transition to GST

While a GST regime appears to be an exercise in simplification, it is likely to increase government interference in business, while also discriminating against the poor. An incremental rather than wholesale shift to a new direct tax regime would have helped in a smoother transition, as in the case of Modvat and Cenvat, says V. KUMARASWAMY.

The changes in the GST regime might lead to overall reduction in compliance travails and increase tax collections but may not lead to greater public good, especially for those who need help.

The economic rationale for many of the recent spate of proposed amendments in tax and corporate laws is difficult to grasp. Any developing or emerging market would require periodic revisions in tax laws so that they provide a framework for the free play of market forces in determining prices and/or allocation of resources even while the government’s direct role recedes into the background.

Some of the proposals regarding corporate laws and direct taxes seem to be tightening the government’s grip rather than relaxing it, even if one concedes that considerable simplification has been attempted. The effort at simplification in GST introduction is a case in point . It increases interference and overlooks equity considerations.

The changes might lead to overall reduction in compliance travails and costs, and increase tax collection and collection efficiency but it is doubtful if it will it lead to greater public good, especially to those who need help.

One also has serious misgivings on whether the over-simplification in rate structure being proposed will sustain itself, whether the transition will be as smooth as in the case of Cenvat implementation. The introduction of GST does not seem to take into consideration broader social and economic objectives. Let us see how.

EQUITY ISSUES BYPASSED

First, a single rate structure of GST, one where the rich and the poor pay the same tax, is iniquitous given the disparities in income in India, which have only grown during the reform years. Even at equal rates of taxation, the burden on net consumption is more on the poor.

At the BPL level the entire income is consumed and at a level above, savings is nominal. These segments must constitute 70 per cent of our population. Bulk of the savings happen at the highest end (20 per cent ), which may be saving 50 per cent or more to pull the average savings rate of the economy to 37-38 per cent of GDP.

Thus a GST of 16 per cent translates to 16 per cent of the total income for the poor whereas the same rate becomes 8 per cent for someone at the highest income bracket who is consuming only half his income. The excise regime (before Cenvat with all its drawbacks) and even Cenvat was much more sympathetic to this and aided the poor by fixing lower rates for wage goods or articles of consumption of the poor. A single-rate GST and the proposed low (or NIL) wealth tax is altering the degree of progressiveness of our taxation structure to the disadvantage of the BPL population. A single GST might be more appropriate for the nation only when most of its population is way beyond “below poverty” line.

Second , India needs the full breadth of tax policies for delivering on or correcting so many social and economic disparities. Most advanced countries are through with solving these basic disparities and need only largely concentrate on economic stabilisation as the main objective of fiscal or monetary policy. And they have chosen to depend heavily on monetary policy to do this, as seen recently during the financial meltdown.

GST will virtually remove fiscal policy as a tool for achieving any of the social and economic objectives and leave the entire task to monetary policy, which is largely ineffective in India, given the low levels of monetisation.

More than half the population would actually need government help through tax policies on a sustained basis or during a crisis. We saw this during the farmers’ distress and the government’s proposal for the debt waiver.

Many of the debt-ridden farmers had borrowed from local money lenders and many of the distressed simply did not fall within the radar of formal systems. Much of Rs 60,000 crore relief announced remained on paper.

Tax equity need not be the only objective of taxation. In India we need it for achieving social, regional and economic equity as well. It is important that we retain this within the States’ domain.

Third, the argument that GST is an effective plug on tax leakage and does away with administrative interference is far from convincing. The proposed compliance structure may be laudable, but only in theory. To be effective, GST has to be implemented right through to the retail level. On most products the gross margins given to final retailers is about 10-12 per cent. On this, if one could evade the GST of 16 per cent, it is almost 2 per cent of sales – the kind of net margins on sales most retailers end up making. There will be a definite temptation to show just as much sales as to absorb the input taxes paid.

This will result in the tax authorities asking for physical stock reconciliation for cross verification — first for internal consistency and next with third party suppliers and buyers. And soon enough, more rules and regulations will follow which negate the spirit of the professed self-assessment.

Fourth, the tax cascade. Our indirect tax systems are supposedly cascading, making it difficult to trace the net effect of any proposal to final products. This makes it tricky to target and deliver benefits and incentives to select segments.

GST will make it easy to trace the tax impact but the single-rate structure will almost make it impossible to use it as an effective instrument of fiscal policy. The proposed GST has all but abolished the tax rebates and incentives from its ambit. The main weapon left for the States is to refund taxes if they are serious about providing incentives to any select segment.

TRANSITION TOO RAPID

Incentive administration through tax rate adjustments is far more efficient.

A section embedded in the law is less discriminatory than hand-outs, which are discretionary. If all incentives have to be delivered through only cash transfers and subventions, it can only lead to corruption and timing uncertainties. There will simply be a substitution of the retail corruption with wholesale corruption.

Lastly, the implementation process marks a wholesale rather than incremental shift, bringing with it associated problems. India’s implementation of Modvat and Cenvat (over 20 years) was a smooth Experience only because it was implemented gradually.

Wholesale changes make for easy political targeting, whereas small but successive incremental changes through the annual budgets do not. It gives time for people to adjust and provides the government enough room to retract or manoeuvre tactically. Radical changes make for potential conflicts between tax collectors and tax-payers. Gradualism would have been more welcome.

(The author is CFO of a large paper company. He can be reached at kumarviru61@yahoo.co.in )

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