Project work for Indirect Taxation

[Examining the Impact of GST on Indian economy]

Submitted to: Mr. U.P. Singh Submitted by: Suvigya Awasthy Roll No-138 IX Semester. B.A. LL.B. (Hons.)

ACKNOWLEDGEMENT No work of any substance can be the exclusive effort of one individual. This project work is no exception. This work would not have been possible but for the generous support of my friends who invested a lot of their precious time in discussing this work and coming out with ideas. I would also like to thank my teacher who through his brilliant teaching inspired me to take up this topic and do a proper research on this contemporary issue.

Contents
Introduction .. Undestanding Tax system in India2 Why GST when we have VAT?......................................................6 GST Design in India..8 Impact of GST on Economy - International Experiences11 Impact of GST on Indian Economy12 Conclusion .15

Introduction The Finance Ministry of India placed the One Hundred and Fifte enth Constitutional Amendment Bill in the Lok S ab h a on 22nd March, 2011. This Amendment Bill is hugely significant a s it introduc the Goods and Service Tax (GST) in the Indian es Constitution. Introduction of GST marks the most significant reform in Indian tax system and easily one of the most important economic reforms in India. The Bill still has along journey to m ake before it is includedin the Constitution a s it would now be discus sed in upcom ingParliam e ntary ses sions. One expects vigorous debate on this front am idst m em bes. But still for GST to com e to this level is itself a feat given the huge r challenges with the tax proposal. The FinanceMinister in the FY 2011 U nion B udgethas proposed to introduce GST -12 by April 1, 2012. This is the third such tim eline proposed by the Finance Minister after m issing two previous dates. It will be interesting to se e whether GST is finally introduced in 2012 . This paper is an attempt to unde rstand the impact of GST on Indian econom y.The paper will start with a snapshot of the current taxation system in India and how GST will changethe taxation system. It then looks at the GST design in India w hich has beenadapted to suit the Indian taxation system. The paper ends with the probable impact of GST on Indian econom y and also touch on expe es rience of GST in other international economies.

. Understanding Taxation System in India India is a federal country and both C entre and States have their own rights to collect taxes. Each state is independent levyingand collec taxes. The taxation pow es are in ting r defined clearly in the Indian Constitution. Centre collec all the direct taxes (incom e ts tax, corporate taxes etc) along with the Indirect taxes like Service Tax, Exci e duty and s Custom s duty. The States collect indirect taxes like VAT on goods, CST and Local Taxes. These revenuesstates keep with themselves. Earlier instead of VAT, States had sales taxes on various goods. Now states have replacedsales taxes with VAT. Each state has adop its ted own structure of VAT with different duties and structure. A Finance Commission is appointed to look at the transfer of a certain percentage of the taxes collec by the Centre to the State. The Finance Commis sion defines the ted rules and conditions for the transfer of resources. In an earlier taxation system, people paid taxes at various levels. There was no system of getting a rebate on the taxes paid previou w hile paying the inputs. This is also sly called as cascading effect. Ideally the taxes should be based on value addition and the producer should pay taxes on whatever value he adds to the product. In the absenceof such a system, producers ended up paying much higher taxes. Higher taxes are a barrier for business and discourage business activity. The businesses instead spend tim e trying to sav e taxes leadingto distortions and a parallel econom y.A large number of enterprises prefer to stay out of the taxation system and avoid payingtaxes. High taxes also lead to lobbying activities where produce of a certain sector ask the governm ent to rs lower/waiver taxes for their sector. This also leads to multiple taxation rates for multiple products and further increases inefficiency in the system.

A Value Added Taxation system is se e n as a way to negate this cascading effect. VAT taxes goods at each stage and on the value addition done by the enterprise. In a VAT system the idea is also to have a single rate of taxation for all the good As this may not s. be practically possible, the Governments try and m inimze the number of taxation rates. i The multiple tax rates will take time before they are m erged into one rate. The Centre was the first to adopt VAT with a selected group of commodities in 1986 and was called MODVAT. The numb of commodities was increased gradually in er form of CENVAT in 2002 The Service Tax was also made part of CENVAT in -03. 2004-05. GST is an extended version of Value Added Tax (VAT) and aim s to cover all goods and services. VAT cove mostly goods and GST cove all goods and services. VAT rs rs was selectively applied in India (discussed later) and GST is an attempt to get rid of w eak n e in the VAT structure. sses With a GST in place, all these indirect taxes should be m erged into one tax. Ideally, these taxes will be collec by the Centre which will then be transferred to the States ted via a rule/formula. This will requi e changesin the constitution as Centre can only tax r goodsat production stage and on Services. The States can only tax sale of goods. H ence, States cannot tax services and Centre cannot tax sales of goods. The States cannot also tax imports. All this needsto be changed with the GST and hence would require am endm nts in e the Indian Constitution. That is the reason why the 115th Constitution Amendment Bill has been introduced (expl ined in the introduction) a Hence, implementation of GST was always seen as a concen for States as they r surrender their powe to tax. This is a very difficult issue and as a result num bes of rs r

discussions have followed betw eenthe stakeho lders (covered later). Similar is sues w ere seen in implementation of State level VAT as w ell. H ow eve, the r problem then was inter-states. As expl ined above, before VAT States had sales taxes a with multiple rates. States w ere often see n in a sales tax war with other states. In the war states competed with each other offering lower tax rates to certain industries to set units in their states. This resulted in revenueloss for both the states. Hence with Statelevel VAT attempts w ere made to make it harmonious starting with asking the states to stop this war. The design of VAT system in each state has also been done in a uniform fa shion keepingthe distinctive state econom y in mind. The First Discussion Paper on GST review sthe experi nce of VAT system in States and e summarizes it as: As a cons eq uenc e of all these steps, the States started implementing VAT begin ning April 1, 2005. After overcoming the initial difficulties, all the States a nd Union Territories have now implemented VAT. The Empowered Com mittee has be e monitoring closely the n process of implementation of State-level VAT, and deviations from the agre e VAT d rates has be e contained to less than 3 per cent of the total list of com modities. n Responses of industry a nd also of tra de have be e inde e encouraging. The rate of growth of tax n d reven ue has nearly doubled from the average an n u rate of growth in the pre-VAT five year al period after the introduction of VAT. Just like GST now, states were worried at the time of VAT on losing revenu At that es. time Finance Ministry promised to make up for any losses from transition to the VAT. Even State Finance Ministers understood the transition costs w ere short-lived and w ere supportive. However, with GST is sues are more com plexas States loose their powerto tax and all the pressure is on Finance Ministry

to justify the need to move to GST. The Centre has proposed to set a Rs 5 0 ,0 0 0 Cr fund to help states w hi h have a shortfall in tax revenues c after GST.

II . Why GST when we have VAT? GST is similar to VAT in term s of the value-added approach. The question that com es to mind is - India already has VAT then why should someone go for GST? Moreover, it seem sto be very com plicted and a difficult exercise, then what are the reasons? a Limitations in Centre VAT system: There is CENVAT but several taxes are still out of the ambit like surcharges, additional customs duties etc. In som e goods w e get input tax and not in others, making the tax filing system complex and cumbersome. Limitations in State VAT system: The States also have VAT but again story is the sam e.Many taxes like luxury taxes, entertainm enttax etc, are not included.There is no input tax credit in case of CENVAT paid on certain items. Interstate Sales Tax (CST): Though it is an important source of revenuefor states it is see n as very burdensom e by busines ses. The companies make goods in one state but on distribution inside the country, end up paying taxes in each state. They are supplying go within the country and should just be taxed at one place. ods Inclusion of Services in VAT system: Production of goods is b ecause of both physical produc tion and services. But Services are taxed only by Centre and

that too is done selectively. The Services need to be taxed at State level and integrated with the Goods VAT system as shown in the exam pleabove. International Standard: GST is becom ing an international standard and it is important India also has one. There are many factors before international com p anies w hile choosing a country for its business and taxation system is one very important factor. With other countries having GST and India not having one, the com p anies are likely to opt for former ahead of India for locating their busines ses. Likewi e s Indian com panies may also prefer to increasingly set their base s in other countries where tax system is more efficient. Dr. Vijay Kelkar, Chairman of the Thirte enth Finance Commission has been one of the most vehem entadvocates of GST in India. In a speechhe cities work of em inenttax economst Prof. Charles MClure. Mclure identifies six characteristics of a w ell designed i GST in a federal system. Uniform rate of taxation within a givenjurisdiction, ideally at a singlerate Sales would be taxed under the destination principle. Low costs of compliance and administration Each levelof government to set its own tax rate subjectto agreed ceilingsand/or floors A substantivelyCommon tax base for Central and State governments Substantial Co-operation in tax administration betw eenall levelsof government

Kelkar added that first two are important for econ ic reasons; the third for om administrative rea sons and the fourth for political reasons, the last two come into play in a system of multilevel finance such as w e hav e in our country. These principles should be adopted w hile designing GST in India as well.

III . GST Design in India GST was first proposed in India in the U nion Budgetspeech in 2006 It has been -07. quite a journey since then. Box 2 sum marises the tim eline of GST in India. The Empowered Commitee of State Finance Ministers released the first discussion paper on GST in t Novem ber2009.This pap er has specified the features of GST in India. The highlights are: Dual GST System: There will be two kinds of GST, for the Centre (CGST) and for the State (SG ST). The taxes that are m erged into GST is given in the following table Taxes merged under Centre GST Central excise Duty, Additional Excise Duties Additional Customs Duty known as Countervailing Custom s D Special uty, Service Tax Additional Cesse s an d Surcharges Source: First Discussion Pa per on GST Taxes under State GST VAT/Sales Tax Tax on Interstate Sales (CST) This has to be phased out with introduction of SGST. A Local Taxes - Entertainment Taxes, new conceptcalled Inter-state GST or IGST Luxury Tax Service Entry Tax not in Lieu of Octroi

As the table shows, GST has made a start be m erging the various Centre and State taxes into CGST and SGST respectively. But the idea of a PAN India Tax is still missing. The States also would get to tax services under the GST. S om e goods/taxes are kept outside the purview of GST like Purchase Tax, Tax on Alcohol, Tax on Petroleum Produc (crude, motor spirit, high speeddiesel etc). ts A separate accounting system for dual GST: The businesses will need to maintain separate accoun for the two GST. ts No inter system input tax credit: As there are separate accoun for the tw o, a ts

business can get input tax credit paid on CGST can only be utilized for paying Output tax on CGST. Likew se, SG input tax credit can only be adjusted for i ST output tax SGST. There cannot becross utilization of Input Tax betw een CGST and SGST. Inter-state GST: IGST will be introduced to account for Inter State Sales. The Centre will collect IGST on an interstate sale from the exporting state and transfer it to the importing state. The producerand his custom er will be eligiblefor input tax credit on IGST. Taxation Rates: There will be two tax rates for SGST lower rate for necessary and basic importance item s and a standard rate for all other goods. Further, there will b e a special rate for precious of one rate exem p ted for both m etals and there a would list be items. For CGST also a dual rate structure will be CGST and SGST.

adopted in conformity with the SGST rates. For services,

The Governments have still not arrived at GST taxation rates as discussions are still being held am idst m embers. Finance Commission Task Force estimates the revenue neutral rates (rate at which tax collec tion will be sam e in old and new regim e) at 12% - 5% for CGST and 7% for SGST.

Threshold exemption: This is built to keep small traders out of tax net. It is always difficult to monitor small traders and costs are high for the same. H ence the tax system sets thresholds under certain turnover will be which only business above a taxed.

In the VAT system, states have adopted their own threshold limits. Under GST, there is an attempt to harmonize and keep the threshold limits similar across states. The limit being considered is Rs 10 lakh for both goods and services. Howeve, r for CGST the limit is being considered as Rs 1.5 crore for goods and for services to be kept at appropriately high levels. GST Council and Dispute Settlement Authority: The 115th am endmentbill also mentions setting up two constitutional bodies- GST Council and GST Dispute Settlem e Authority. GST Council will make recom nt mendations on all key matters pertaining to GST like taxation rates under both CGST and SGST, exem p tions from GST etc. Union Finance Minister will chair the council with Finance Ministers from states as m em b rs. The Council m em bes may also elect a Vicee r Chairperson of the Council from the members. The Dispute Settlem ent Authority will be responsible for any disputes amidst Union/States/members with respect to GST. The Authority would have one Chairperson and two m embes. The chairperson should be judge from Suprem e r Court or Chief Justice from a high court and appointed by Presidentof India on the recommendation of Chief Justice of India. Two other m em b should be expe ers rts from field of law/economics/public affairs on the recommendation of GST Council.This has beendone to balance the interests of the parties. Overall, the GST system is an improvem e t over the current indirect tax system. It n

merges the Centre Indirect Taxes under CGST and States Indirect Taxes under SGST. But still there is vast scope of improvem ent as it is still far from a Pan India Tax system. The taxes remain under both state and centre. Then issues like exemp tions, dual rate structure etc remain in the system. It doesnot m eet the design principles suggested by Mclure but is still going to be much better than the current system of taxation. The proposed GST system is on the lines with the way India has been conducing its t reforms. India has followed the gradual approach in most of its reforms w here reform is adopted with many of the deficiencies remaining in the system. It is like the skeletal system with just the basics in place. Over a period of tim e, the flesh is addedto the bones to make the reform more com p rehensive. The GST is also likely to move in the sam e direction.

IV. Impact of GST on Economy - International Experiences Most coun tries have adopted VAT system and GST is considered similar to a VAT system. It is possible that som e econ omies that have adopted VAT system is actually a GST as w ell. S o w e really do not know the broad experiences of most economes and i stick to countries which call their tax systems as GST based. GST system has been adopted in a few econom ies Canada, Australia, New Zealand and S ing apore. Hong Kong proposed to introduce it but had to abandon it am idst stiff opposition. Tom Bolton and Brian Dollery in a paper com pare impact of the GST in Australia, C anada and New Zealand (An Empirical Note on the Com parative Macroeconomic Effects of the GST in Australia, C anada and New Zealand, 2004).

Over a long term there are improvements across the macroeconom ic ariables but there w ere short- term glitches. Inflation did seem to rise in the years of introduction but was mainly blam ed on the administration for the sam e. The impact on revenueand current accounthas been very impressive with sharp gains seen in all the three economies. In Australia there was a m ore dramatic impact of GST on the econo my. Before GSTs implementation, consum ers rushed to purchase goods that they perceived would be substantially m ore expe nsive post-GST. After the tax, consumer consumption and econom ic growth declined sharply initially. In Q1 2000,Australian econom yrecorded negative econom icgrowth for the first time in more than 10 years. Consumption and growth soon returned to normal. There was some neg ative impact on price of real estate as w ell but the market rose and property prices and demand increased sharply in 2002-04. Australia Introduction year 2000 Price Changes Short run one off effect, Economic Growth RevenueEffect Current Account Introduced during sustained economic Revenueexce eded growth period expectations Slight improvement since introduction Source: Tom Bolton and Brian Dollery (2004 ) New Zealand 1986 Short run spike in prices, no longerrun increase Introduced at the end of reces sion, Revenueexce eded subsequent upswing Expectations Rapid immediate improveme longer nt, term stabilization Canada 1991 Short run spike in prices, no longerrun increase, price regulatory body Introduced in midst of major recession, criticized as Revenueexce eded Expectations Dramatic Improvement since introduction of

In another study, Hamilton show edthat GST increased the real output of the C anadian econom yby 1.4% of GDP, principally through an increase in the productivity of capital and total

factor productivity. The sectors like transportation, utilities, services and agriculture expe riencedsignificant gains.

V. Impact of GST on Indian Economy The studies a ssessing impact of GST are limited as the design of GST was not clear till the First D iscussion Paper. Thirte enth Finance Commis sion has unde rtaken a study with NCAER, a Delhi based think-tank on cost-benefit analysis of GST regim e in India. The highlights of the report were: Medium term gains: GST could increase Indias GDP som ew hee w ithin arange of r 1.7%. The com p arable dollar value increm ent is estimated to be betw een $9.5 billion and $18.6 billion respectively. Long term gains: The additional gain in GDP, originating from the GST reform, would be earned during all years in future over and above the growth in GDP w hich would have been achieved otherw ise. It estimates present value of total gain in GDP betw een $325 billion and $637billion. This is nearly 30-60% of the size of Indian econom y currently!

0.9% to

Export gains: GST will lower the overall tax inputs in supply chain of goods and services leading to lower prices of Indian goodsand services. This will increase the com peitivene of Indian goods and services in the international market and t ss give boost to Indian expo The uniformity in tax rates and procedu across the rts. res country will also go a long way in reducing the com pli ance cot. These gains are s expeced to vary betw een 3.2 % - 6.3% with corresponding absolute value range t betw een $5.4 billion - $10.7 billion, respectively. Imports are expeced to gain t som ew he betw een 2.4 and 4.7% with corresponding absolute values $6.9 billion and re $13.6 billion, respectively.

Others: GST would lead to efficient allocation of factors of produc tion. The overall price level would go down. It is expeced that the real returns to the factors t of production would go up. NCAER results show gains in real returns to land ranging betw een 0.42 and 0.82 per cent. Wage rate gains vary betw een 0.68 and 1.33%. The real returns to capital would gain som ew hee betw een 0.37 and 0.74%. r Kelkar add s that GST could help addproduc tive em ploym ent of as m uch as 4 to 5 million. Barring impact on economy, GST could helpthe consum ers as well. The lower taxation will lead to lower prices of goods and services.

NCAER sums up the findings as: implementation of a comprehensive G ST in India is expected to lead to efficient allocation of factors of production thus lea ding to gains in GDP a nd exports. This would translate into enhanced econom ic welfare and returns to the factors of production, vi . land, labour and capital. They add that as with any other m ode z lling exercise, the results are subjectto certain limitations. How eve, going by the above international expe r riences there could be tw o additional problems.

Inflation: Most of the international case studies show an inflation spurt in initial months of GST implementation. In Australias case w e saw spurt in prices of goods which Australian consumers thought would becom eexpensive after the GST. Much of blam e for inflation is accorded to the various regul tory bodies and unce a rtainty over the new tax regime.The inflation situation stabilizes as implementation gains pace and is understood by consum ers and producers. In Indias case inflation could be critical as unlike devel ped coun o tries profiled above, India has far more inefficiencies in supply chain in local markets. The Indian GST reform is far larger in scale com p ared to above econom ie. These rigid s inefficiencies along with higher information asym m ery on probable impact of t GST could push inflation higher in initial day s of implementation. Indian econom y is already plagued with persistent high inflation and this new reform could further test inflation further. Tax Revenue Shortfall: RBI in the State Finances Report (2010-11) said the revenue implications of GST are likely to vary across states. The Centre and the States are still discus sing various aspects of GST like taxation rates, revenuesharing m odel betw eenCentre and States etc. As there is still uncertainty over the final blueprint of GST, it is difficult to estimate the impact of GST on state finances. Other issues are enhancing the administrative capacity of states and building IT (Information technology)infra structure to capture the full benefits of GST. The report points that VAT led to improvement in tax revenue for most states. Howeve, just like VAT there could be som e short-falls in revenuesin som e states r over a short- term . The central gove rnment has already proposed a Rs 50,000Cr fund to help the states which suffer from the short-fall. H ow eve a higher shortfall r, could lead to both Centre and States to borrow more from the markets. This will be critically watched as it has further ramifications on fiscal deficits, interest rates

and inflation.

VI. Conclu sion Goods and Service Tax is easily the biggest taxation reform in the country along with the proposed Direct Tax Code. In term s of macroecon ic reforms too, it will be at om tops with the various reforms taken since 19 90 It will also serve as a useful case s. study for other econom ies which are contemplating to implementGST. The sheerscale of GST project to bring all indirect taxes in India under one fold is a major achievem ent and needsto be com m ended. The proposed GST is not the desired and true form of GST. But a single indirect tax cannot be done as Indias federal structure has to be preserved. GST is also expeced to bring many benefits to the Indian econom y.Though, all these t benefits are based on the assumption that overall taxation structure is less bureaucratic and cum be rsom e than present. The implementation is going to be crucial so that the promised benefits are realized. The Government also needs to be w eary of inflation spurts in initial implementation p hase of GST as poin by expe ted riences from international economes. Ideally, one i should be first easing all these state-w ide inefficiencies and then im plem ent GST. However given the challenges in India, the policym akers are hoping GST will help ease these inefficiencies and elim in them over a period of time. ate

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1. ECONOMIC AND POLITICAL WEEKLY 2. CORPORATE PROFESSIONALS TODAY

3. SEBI AND CORPORATE LAWS