The President has given his assent to the Constitution (One Hundred and First Amendment) Act, 2016, enabling the implementation of a nationwide goods and services tax (GST). The next steps for implementation of the GST need to be taken by the GST council, which will be constituted after the Act becomes effective. Like the small hinges which swing open massive vault doors, the council will be the gateway to the successful implementation of GST, the creation of a national market and sustained accelerated growth.
The council embodies a radical shift in structure, functions and responsibilities when compared to the empowered committee of state finance ministers, which has so far been coordinating GST issues.
The council is a constitutional body, with correspondingly onerous duties, outlined in Article 279A. It needs to operate in a transparent, predictable and consistent manner so that it commands the respect and credibility not only of its members but also of all the stakeholders across the GST spectrum—ranging from manufacturers, traders and service providers to consumers, civil society, academics and the nation at large.
Given that it will be the arbiter of most indirect taxes in India across the Centre and all states, it must aim to become a 21st century world-class institution epitomizing cooperative fiscal federalism at its best.
1. Rules of procedure
The council has crucial responsibilities relating to finalizing the tax base by recommending the goods and services to be exempted, the threshold for taxation, the revenue-neutral rate (RNR) and the rate structure.
These are far-reaching issues which will impact the economic interest of all the states and the Centre and will therefore be subject to intense debate. In the interests of its credibility and predictability, it is essential that the first item of business of the council should be to finalize its rules of procedure. The council’s functioning over the next six months/one year will be critical to the successful roll-out of GST.
2. Policy on compensation and delegated legislation
Incentives drive all human behaviour. State and Central governments are as susceptible as humans to the power of incentives in driving their behaviour in the council. The council needs to ensure that, as far as possible, there is a convergence of incentives among all its members before moving on to the main discussion on GST. This is best addressed by getting the compensation formula right and minimizing delegated legislation.
Parliament has to make a law to provide for compensation for revenue losses to state governments, based on the recommendations of the council. To ensure that its discussions on the structure and implementation of GST are not tainted with the problem of moral hazard, the council should, immediately after finalizing its rules of procedure, finalize its view on the payment of compensation.
All states may prefer payment of 100% compensation for all their losses for the full five years, the period mentioned in the amendment Act. This proposition should be resisted stoutly, as states may then become indifferent to the revenue collection under GST for this entire period.
This issue can be addressed best by providing for a tapered compensation formula: 100% in the first year, 75% in the second year, gradually tapering off to 25% in the last year. This will ensure that states have a strong, continuing and increasing stake in the success of GST. A similar compensation formula was adopted when value-added tax (VAT) was implemented in 2005.
3. Transparency and predictability
To promote investment and growth, changes in taxation policy should be transparent and predictable. There should be no vacuum of uncertainty. Manufacturers, traders, service providers and consumers all over the nation, and consequently, the economy will be affected by the recommendations of the council. Design features and changes to the system should be decided by the council only after following a prescribed procedure and giving due notice to all stakeholders.
Article 269A mandates the council to make recommendations on three issues which may have limited relevance to the GST roll-out.
These are (a) special rates to deal with natural disasters, (b) special provisions for the North-Eastern states, and (c) the date on which petroleum products will be subjected to GST.
To avoid uncertainty, the council may like to indicate when and in what manner it will address these three issues. For example, it could state upfront in which year it will recommend (or at least consider) inclusion of petroleum products in the GST base. To allow the new system adequate time to settle, it could also examine after what period or under what circumstances it will review its initial recommendations on GST rates. Given the preparatory steps required, it may be challenging to bring GST into place by 1 April 2017. The council should also recommend, based on its work plan as well as the need for providing lead time to trade and industry, the earliest possible date for the implementation of the GST in the country. These issues should form the basis of its transparency policy.
4. Inclusiveness
The council singularly is clothed with legislative, executive and judicial powers. It will recommend GST legislation, oversee implementation of the GST in the country and set up a mechanism to adjudicate disputes between its members.
These are sweeping powers, making it akin to a regulator for GST. It should, therefore, exercise its powers with the utmost inclusiveness. There are a number of steps that could be taken to ensure inclusiveness. These could include (a) putting up draft consultation papers in the public domain and inviting comments, (b) regularly inviting trade bodies, professional associations, academics and consumer forums to submit their view on issues being deliberated by it, (c) participating in information, education and communication programmes in association with state and Central governments, and (d) setting up an interactive and continuously updated website in all languages. These issues could form the basis of its inclusiveness policy.
5. GST law and the rate structure
The structure and content of the Central GST, inter-state GST and GST laws, the RNR and the rate structure, which are the subject of intense debate all over the country today, should only have the fifth priority in the council’s order of business. These decidedly important issues should be addressed only after the four issues outlined above have been addressed satisfactorily. This is so for two reasons.
First, without an enabling, conducive, predictable, and transparent environment in the GST council, productive discussion on the intricacies of the GST may be difficult.
Second, while it is relatively simple to determine the RNR for the Central GST, computing the RNR for states individually is difficult at best and impossible at worst.
There are difficulties in estimating the share of service tax of individual states given the lack of state-wise service tax collection data.
In any case, as was seen during the implementation of VAT, finance ministers are notoriously conservative in their estimation of their respective state’s RNR. Expectedly so, given the extreme dependence of state governments on indirect tax revenue. The RNR represents the rate which, when applied over the entire tax base, will generate the current revenue. Such an approach ignores the fact that the state and Central governments, being large consumers of goods and services themselves, will, through the application of lower taxes in the GST regime, reduce their expenditure significantly. To that extent, they may need to generate lower revenue to balance their budgets after GST is implemented.
State governments may, therefore, also like to look at the budget-neutral rate, the rate at which, given lower expenditure, their expenditure budgets remain neutral.
This will be lower than the RNR, and therefore provide a safety cushion for state (and Central) governments.
The Thirteenth Finance Commission had recommended an RNR of 12% over a broad base and with few exemptions.
The Arvind Subramanian panel had suggested an RNR of 15%. The actual rate structure will depend upon the exemptions and the threshold of the tax. Given the need to incentivize growth, it may be desirable to keep the RNR between 12% and 15%. And the GST rates will not be cast in stone. If necessary, they could be revised after a review undertaken by the council.
6. Capacity
The GST council will face significant challenges in addressing the issues identified above. Tax departments in most state governments often have limited staff resources to examine GST-related issues from their government’s standpoint.
The council needs to be aided by an independent and technically strong secretariat, not only to support the council’s requirements, but also to assist state governments in this regard. Given its stature as the body driving GST implementation in the country, the secretariat will need to be both financially as well as technically independent.
To this end, the Thirteenth Finance Commission had given a grant of Rs30 crore to the council’s predecessor—the empowered committee of state finance ministers. The council secretariat must be adequately staffed to enable it to independently propose, analyse and evaluate GST-related proposals so that it can provide objective advice to the GST council.
Conclusion
Over the last 66 years of the Indian republic, the Centre and the states have remained good fiscal neighbours. This is because the Constitution allotted mutually exclusive tax bases to each.
This tax fence between the Centre and the states is now being dismantled by the GST. For the first time, they will share a common indirect tax base, with the GST council providing the modality for doing so.
Whether such a sharing of tax base is both harmonious and sustainable will be the true test of the success of cooperative fiscal federalism in India. The GST council bears the heavy burden of proving that it can be so.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.