GST in India: Rationale,

Design Issues, and

Implications

Mukul G Asher
Professorial Fellow, National University of Singapore
Director, Public Policy, Global Village Foundation
E-mail: mukul.asher@gmail.com

Presentation at the India Economic Seminar, Bangalore, July 30-31, 2016

1

Organization
Introduction
Rationale in India
Indias Economic Context
OECD Indicators for VAT
GST: Design Issues
GST: Economic Implications
GST: Implications for Businesses
GST: Implications for Tax administration and
Compliance
Progress and Prospects for GST in India
2

Introduction
For any modern economy, it is a essential to structure a tax system
comprising to broad-based- low nominal rate taxes. These are the taxes
on income and profits and on domestic taxes goods and services.
Among the latter, Value Added Tax(VAT) or Goods and Services Tax
(GST) (can be used interchangeably) is the primary component.
However within this category, the details of VAT or GST design,
implementation and other aspects, including political economy, can
vary significantly, resulting in very different implications.
Therefore the Text book treatment VAT GST needs to be modify for a
given context, particularly as starting point is not likely to be Pareto
efficient point usually assumed in the text books ; and political
economy aspects are inherent in both GST design and implementation.
So context specific analysis needed.
This presentation focuses on the rationale for GST in the context of the
Indian economy, and focus on the key design issues and implications
for the economy, businesses, and tax administration and compliance .

GST: Rationale in India

The main rationale for GST in India stem from the following:
To obtain Constitutional authority to levy sales tax on both goods & services by both the
Union Government and the States.
To reduce distortions, particularly in logistics costs, and compliance costs arising from
distinguishing between goods and services, accentuated by each state levying its own sales
tax on goods, and other distortive taxes on goods such as excises, entry tax etc.
To remain competitive and deepen international linkages by moving from origin to destination
based taxation, with greater feasibility of exempting exports from GST, and taxing imports for
GST.
To potentially improve accounting standards of businesses ( among the major reasons for
introducing VAT in Europe during the 1950s and 1960s); and to improve government data
bases for improving tax compliance of taxes on Income and profits and on Domestic Taxes on
Goods and Services.
All of the above is to be undertaken in a Federal context, with dual level GST. Few parallels in
the world of such an ambitious tax reform undertaking.

Indias Economic Context

Indias International Linkages
GDP 2014 Current Exchange Rates USD 2.1 trillion
GDP 2014 (PPP) USD 7.4 trillion
Trade per capita (US $) 2012-2014 USD 822
Trade to GDP Ratio 2012-2014: 53.6
Total Merchandise trade 2014 billion USD 784.6
Exports 321.6 (1.69)
Imports 463.0 (2.43)
Total Services Trade 2014 Billion USD 302.5
Exports 155.6
(3.15) Imports 146.9 (3.07)
Figures in () are % of world total
Total Merchandise+ Services Trade 2014 USD 1087.1 Billion.
Trade Deficit USD 132.7 ( 6.3 percent of GDP)
Source WTO http://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Country=IN&Language=F

Economic Context
Merchandise Trade, Exports: India
(2014)

Source: WTO Trade Profiles

6

Economic Context
Merchandise Trade, Imports:
India (2014)

Source: WTO Trade Profiles

Economic Context
Services Trade, India (2014)
Breakdown in Economys Total Exports
(by principal services item)

Percent

Goods-related services

0.2

Transportation

12.0

Travel

12.7

Other Commercial Services

75.1

Breakdown in Economys Total Imports

(by principal services item)
Goods-related services

0.2

Transportation

52.6

Travel

9.9

Other Commercial Services

37.3

Source: WTO Trade Profiles

8

Economic Context
In Services , Transportation services account for only 12
% of Total Exports, But 52.6 % of the Imports.
It is in this sector therefore India will need to be a lot
more competitive if it is to manage its large and
persistent Trade Deficit
In Merchandise Trade, a less well known indicator, is
moderately large trade surplus contributed by the
agricultural sector. Thus 2014 agricultural products
were 13.5 % of the exports, but 5.9 % of Imports. How
to increase this surplus is a challenge for India.
As agriculture sector is especially challenging in GST
administration, how GST rules are structured for this
sector will impact on meeting the above challenges.
9

Economic Context
Indias Total Remittances in 2015: USD 72.2 billion ( 12.0% of
Global Total)
Indias Total FDI
FY 2014 USD 36.0 billion
FY 2015 USD 44.9 billion
What is the relevance of Indias external integration for tax policy ?
Lessening of conventional tax policy autonomy; complexity of tax
transactions (international taxation becoming a major function);
trade and economic agreements creating unintended effects on
competitiveness of firms based domestically; need for aggressive
global economic, commercial and trade intelligence and research
are some of the implications.

Source
http://siteresources.worldbank.org/INTPROSPECTS/Resources/334934-1199807908806/4549025-1450455807487/Factbookpart1.pdf
http://www.ibef.org/economy/foreign-direct-investment.aspx

10

Economic Context
Domestic: In the name of socialism, an inherently regressive tax system
developed
In India, which GST could help potentially mitigate. (textbook ideas of GST being
regressive or not miss this context)
India (2014-15) data in () is share of GDP
GDP: INR 128.8 trillion.
Combined Expenditure: INR 35.4 Trillion (27.5%).
Combined Tax Revenue: INR 22.4 trillion ( 17.4%).
Combined Operating Revenue: INR 26.5 trillion ( 20.5 %).
Overall Budget Balance: -2.46
Fiscal Balance: -6.38
Primary Balance= -1.60
Total Liabilities of Union Government = 48.2%
Total Liabilities of State Governments = 20.0%
Combined Liabilities: 68.2%
( Estimated from Indian Public Finance Statistics , and Handbook of Statistics on the Indian Economy by RBI)11

Economic Context
Combines Tax revenue of Union and
States : 2013-14
Corporate Income Tax : INR 4.5 trillion ( 3.4 % )
Individual Income Tax : INR 2.8 trillion. ( 2.2 % )
Customs Duties : INR 2.0trillion ( 1.6% )
Union Excise tax duties : INR 2.1 trillion ( 1.6 %
)
State Excises : INR 1.0 trillion ( 0.8 % )
Total Excise: INR 3.1 Trillion ( 2.4 % )
Service tax : INR 2.2 trillion ( 1.7 % )
General Sales tax : INR 5.6 trillion ( 4.4 %)
General Sales Tax+ Service Tax +
Excises=4.4+1.7+2.4=8.5%

As % of 2013-14 GDP

12

Economic Context :
Trends in Revenue Foregone/ Tax Expenditure
Tax Head

2013-14
(crores)

% of Gross % of GDP
Tax
(2013-14)
Revenue

Corporate
Tax

76116

6.7

0.7

Source:
Budget
Personal
40414
3.5
0.4
documents
Income-Tax
NOTE:
Major tax
Excise Duty 195679
17.2
1.7
expenditure
Customs
260714
22.9
2.3
s from
Duty
excises, and
though not
Total
572923
50.3
5.0
separately
Gross Tax
1138832
10.0
given in
Revenue
state sales
How is revenue foregone or tax expenditures estimated? taxes.
How accurate do you think these estimates are? These are
soft numbers, so are not mixed in the budget with other
13
numbers, but stated separately.

KEY VAT indicators in

OECD Countries
The material is primarily from OECD (2014), Consumption Tax Trends 2014:
VAT/GST and Excise Rates, Trends and Administration Issues, OECD Publishing.
http://www.keepeek.com/Digital-AssetManagement/oecd/taxation/consumption-tax-trends-2014_ctt-2014-en#page3

14

15

International Guidelines still being developed

16

17

Value Added Taxes as Percentage of GDP

For
the
OECD
Countries,
VAT
revenue
as
a
percentage of GDP
ranged from 2.7% in
Japan to 9.7% in
Denmark in 2012. US
levies retail sales tax,
not VAT.
The OECD Average
was 6.6 % in 2012.

18

Source: OECD (2012), Consumption Tax Trends 2012: VAT/GST and Excise Rates, Trends and Administration Issues, OECD

VAT Rates
There is a wide range of lower rates, exemptions and special
arrangements under VAT that are frequently designed for non-tax
policy objectives. Uniform single rate for both the goods and the
services is usually an ideal for tax neutrality, and for ease of
administration and compliance. But it is not always achieved,
particularly once the rate approaches 15 percent
VAT preferential treatments are widely used in OECD countries,
for equity or social objectives (basic essentials, health, education,
etc.) or for practical (e.g. financial services) or historical reasons
(postal services, letting of immovable property, etc.).
Broadening the tax base and eliminating reduced rates may help
achieve the full potential of VAT.
19

Country
2014

Implemented

VAT/GST Rates : OECD

Countries
1992
2002
2012

In 2014, the
VAT
in
Canada was
as low as 5%
(though
in
Canada,
provinces
levy separate
VAT), while in
Hungary
it
was 27%.

The
OECD
un-weighted
average rate
for 2012 was
Source: OECD (2012), Consumption Tax Trends 2012: VAT/GST and Excise Rates, Trends and Administration Issues, OECD
20

Considerations in setting VAT

Threshold
Empirical evidence suggests that a relatively small
proportion of firms account for large proportion of
potential VAT revenue.
More effective to concentrate resources on the largest
tax payers, as the revenue to be raised from smaller
firms is seen insufficient to warrant the resources
required for its collection.
Despite significant variation, a useful rule of thumb is
that the largest 10 percent of all firms account for 90
percent or more of all turnover.

21

Considerations in setting VAT

Threshold
At the margin, a 1% increase in the threshold is initially very
cheap in terms of revenue foregone, but becomes much
more expensive at higher levels of turnover.
If it were not for the costs of administering VAT (incurred by
authorities) and complying with it (by tax payers), the best
threshold would be zero. This would minimize distortions as
well as maximize revenue.
It is important to recognize that administrative costs are not
exogenous: the costs of coping with each taxpayers depend
on design choices as the frequency of audit, the nature of
audit, the complexity of the tax structure, and so on.
Experience indicates that setting too low a threshold can
significantly compromise the political and administrative
feasibility of a VAT.
Some countries have different thresholds by sector, but
22
limited economic rationale for this.

Annual turnover concessions for VAT/GST registration and

collection
For
OECD
countries,
the
exemption
threshold
in
countries varies
from US$1616 in
Netherlands,
to
US$ 110,744 in
the
Unites
Kingdom

23

Taxes levied at national and subnational level in Brazil, Canada,

and India

Source: OECD (2012), Consumption Tax Trends 2012: VAT/GST and Excise Rates, Trends and Administration Issues, OECD
Publishing.

Where:
HST: Harmonized Sales Tax
IPI: Imposto sobre Produtos Industrializados (VAT on industrial products)
ICMS:Imposto sobre Circulacao de Mercadorias e Servicos ( VAT on goods and
telecommunication and transport services)
COFINS: Contribuicao para o Financiamento da Seguridade Social (Contribution to
Social Security Financing), which is targeted for funding of social welfare programs
PIS: Programa de Integracao Social (Contribution to the Social Integration
Program), which was created to fund the unemployment insurance program
ISS: Imposto Sobre Servicos (tax on services)
24

Source: Source: RICHARD M. BIRD AND MICHAEL SMART, 2014

25

Canada
Difficulties in achieving unified internal market are
exemplified by Canadas experience, often set up as an
example to follow for a dual GST in a federal country.
Thus,
The
Economist(
http://www.economist.com/news/americas/21702495-coun
try-far-being-single-market-may-be-about-change-grea
t-provincial
) cities Canadas senate banking committee report that
inter-provincial barriers to trade with in Canada has
cost the economy about USDIO billion a year, with
some provinces finding it cheaper to import than to
face inter-provincial logistics chain.

26
26

GST: Design Issues

Zero Rating vs. Exemption
In GST, the difference between Exemption and Zero rating is critical. An exempt firm must pay input
taxes on their purchases but are not eligible to get credit for the taxes paid, so the only loss of
revenue to the government is at the final stages.
A zero rating means that output tax rate is zero, and all input taxes paid by the firms are to be
refunded. Exports are usually zero rated , relieving exports from input tax burden. The integrity and
the effectiveness of the refund process therefore acquires critical importance

Base Structure
Narrow or Wide?
Treatment of Small Firms
Should Both Goods and Services be Included?
Treatment of state enterprises
Defining place of supply particularly for services

Uber? Ola?

Transition issues

No international experience for a federal country of this size.

Moving from current tax regime to GST will have significant costscould be minimized with good planning

and preparation by all stakeholders. Such planning appears to be insufficient with the possible exception of
the union government.

27

GST: Design Issues

Rate Structure

Single or Multiple Rates?

Determined by relative elasticities.

Realistic?

Number of Taxpayers

Manufactures (M), Wholesalers (W), Retailers (R) - M+W+R

will mean large number of tax payers.
Capacity, Competence, and Resources of the Tax
Administration

Treatment of Agriculture, Real Estate, and

Finance Sectors
Treatment of cross border transactions. In
Federal countries, such as India, inter-state
transactions; or in EU, those designed for a
single market.
Is VAT/GST Self-Enforcing?
Is Any Tax?

28

GST: Textbook Example

Nature of VAT/GST and Retail Sales Tax (RST): Hypothetical
Example
Basic Information/Kind of Tax
A. Transactions (exclusive of
tax)
1. Sales
2. Purchases
3. Value-added (A1-A2)
B. VAT/GST

Total

600
0
600

800
600
200

1200
800
400

2600
1400
1200

4. Tax on sales (10% of A1)

5. Tax on purchases (10%
of A2)
6. Net tax liability (B4-B5)
C. RST

60
0

80
60

120
80

260
140

60

20

40

120

7. Tax on retail sales (10%

of A1/R)

120

120

Source: Constructed by the Author

Notes: M Manufacturer, W Wholesaler, R Retailer.
NET REVENUE TO GOVERNMENT REQUIRES A BALANCE SHEET APPROACH. AS
WITH RETAIL SALES TAX, ALL VAT REVENUE ACCRUES TO GOVERNMENT WHEN
RETAILER TO CONSUMER TRANSACTION TAKES PLACE

29

GST: Design IssuesAgriculture

In emerging economies, agricultural producers are outside
the formal sector or do not have sufficient records for an
accurate measurement of turnover
Physical remoteness, seasonal nature (resulting in a
mismatch of timing in inputs and outputs) complicate
measurement & payment procedures. These result in higher
administrative costs.
The sector is often a particular concern in the pursuit of
wider distributional objectives. A tax on food is either borne
by consumers through higher prices, or by farmers through
reduced real income, or a combination of both.
Both of these options are perceived to be regressive
(essentially for basic unprocessed vegetables). There is
however debate in the literature as many farmers have high
incomes.

30

GST: Design IssuesAgriculture

Moreover, expenditure policies may be more efficient at
achieving re-distributive priorities.
This suggests that agricultural products should be fully
within the VAT system
Either taxed at regular rates or low rates (possibly zero)
Long-term objective in the treatment of agriculture is clear:
tax agriculture as any other good, subject to the normal
threshold.

But high collection costs may validate other methods

Exemption ensures that agriculture is taxed at a reduced but
positive rate because of the absence of relief paid on inputs
Results in distortion in the production and a greater reliance
on untaxed inputs
31

GST Design Issues: Taxing ECommerce

The key issues are:
(a) what should be treated as point of sale?
(b) whether e-business is to be treated as
market place or inventory model of online
business?
The point of sale in online trade i.e., where the
sale is deemed to have occurred, fixes the
liability and incidence of tax. For intra-state sale,
i.e., where the seller and buyer are in the same
state, the Value Added Tax (VAT) rate of that
state is applicable and collected from the seller.
Government of India (2016)

32

GST Design Issues: Taxing ECommerce

For inter-state trade i.e., where the seller and buyer
are located in different states, the Central Sales Tax
(CST) is applicable and is collected and kept by the
state in which the sale originates and not by the
destination state. In the case of online trading/ selling
in the business to customer model, the seller is liable
to pay both CST and VAT, depending on location of
the seller.
In respect of transactions through e-retailers, there is
considerable ambiguity regarding where the sale is
deemed to have occurred and hence, in the incidence
of tax. This leads to dual tax demand, both at the
point of origin as well as at the point of destination.
Government of India (2016)

33

GST Design Issues: Taxing ECommerce

The second issue relates to who is responsible for the
collection of tax. Large e-retailers are of the view that they
are providing an online marketplace to both buyers and
sellers. Under the marketplace model, e-commerce firms
host third-party merchants on their websites and customers
buy goods on the sites from these merchants.
Thus, the third party vendor/seller is liable to collect the VAT
and the online platforms only need to pay service tax on the
commission they charge the vendors listed with them.
However, state governments are of the view that these
online platforms are inventory-based models as many of the
online traders set up warehouses and store goods before
any sale has been transacted. Hence, they contend that
these online retailers are liable for tax on the sales.
Government of India (2016)

34

GST Design Issues: Taxing ECommerce

Various state Value Added Tax Acts and the Central Sales Tax Act, 1956 predate
online retail activities and do not cover them specifically. Tax rates and rules differ
widely across states. Even the definition and treatment of dealers and distributers
differ. Further, if the vendor/third party is not registered under VAT in the state of
destination, monitoring compliance of collection of tax becomes difficult.
GST draft Law has following broad provision for E-commerce:
E-commerce - Tax at source to be deducted on online sales of goods and/or
services
Every E-commerce operator who is directly or indirectly, owns, operates or
manages an electronic platform that is engaged in facilitating the supply of any
goods and/or services or in providing any information or any other services
incidental to or in connection therewith (like Amazon, Flipkart etc.), but shall not
include persons engaged in supply of such goods and/or services on their own
behalf, shall, at the time of credit of any amount to the account of the supplier of
goods and/or services or at the time of payment of any amount in cash or by any
other mode, whichever is earlier, collect an amount, out of the amount payable or
paid to the supplier, representing consideration towards the supply of goods and/or
services made through it, calculated at such rate as may be notified.

Government of India (2016)

35

GST: Economic Implications

Is VAT Inflationary?
Inflation as compared to one time increase in cost of living
How to deal: Manage prices of essential commodities at the time of
implementation; offer a package of benefits to low and middle income
households to ease immediate burden.
Does it raise savings?
Compared to what?
Does it provide better work incentives?
Compared to what?
Is it more equitable?
Compared to what ?

Wealth impact of VAT

Reduces real value (one-off)
NOTE: In the literature (eg Ebrill et al book The Modern VAT, IMF
publication, 2001,)impact of GST on growth rate is not considered
relevant. That is the appropriate approach.
36

GST: Implications for Business

Among the main motivations for introducing VAT (equivalent to Indias GST) in the EU
in the late 1950s was to improve accounting standards in Europe, which were
perceived to lead to lower competitiveness as compared to those of the U.S.
businesses
So one of the relevant criteria for assessing Indias GST is the improvements in
accounting standards of Indian businesses over next several years
New accounting standards being mandated for listed companies should help in
bringing about such improvements.
Another major implication for businesses is the with GST current estimates of
contribution and profit margins, and logistics, supply chain decisions (significantly
impacted by each states sales and related taxes) will need to be re-estimated, and
appropriate changes made in both input procurement and use, and output mix and
pricing. The location decisions for certain goods and services may also be affected.
This will be a major challenge for the businesses. To meet this, fuller design details
will need to be available. Model GST law is a good start, but many relevant details
are yet lacking. The Law still contains some dysfunctional compliance provisions
needing refinement.
In assessing impact on businesses, need to keep in mind that what may be negative
for a sector (such as less opportunities for tax planning or evasion), or for a state
(less revenue from ISGT) may be positive for the economy as a whole from revenue,
efficiency, and fairness perspective.
37

GST :Implications for Tax

Administration and Compliance
GST will result in a shift from origin to destination-based taxes.
Setting up of (GST Network) as information technology platform could help fill the current
information group concerning price, and so provide benchmarking and audit it trail for not
just GST but potentially for income tax. This could help in tax administration and compliance.
For the above, essential to link the computer system of customs and Excise Tax Department,
and income-tax department with each other, and with GSTN.
The Direct and Indirect Tax Boards would need each others cooperation and information
exchange to undertake their responsibilities effectively.
There is a strong case to merge the two boards and create an integrated Indian Tax
Administration Service (ITAS).
As current sales, excise tax and other related officials at the Union and State levels will
implement GST law, changing their orientation towards taxpayers and tax administration, as
emphasized by the Prime Minister during his interaction with the tax officials will be
essential. Organizational change will need to be key part of GST training and capacity
building.
Broadening the Tax Base (through increasing number of taxpayers, and through higher
proportion of tax base being reported), will be the key skills which tax officials will need to
learn with GST.
The GST Draft Law is 190 pages long (too long); and it contains too many discretionary
powers and controls, with insufficient attention to smoother transitioning provisions. These
need to be addressed. Some definitions (eg Taxable value of supply) are vaguely defined,
with potential for litigation. Such vague terms also need to be made clearer with little room
for ambiguity.

38

Progress and Prospects for GST in India

The GST reform has missed several deadlines, one reason for
which is a lack of consensus (with lack of trust between the
two a factor) between Centre and State governments. Prime
Minister Modis Government, current efforts of cooperative
federalism, is well positioned to move towards consensus.
As Constitutional Amendment needed, earliest start date for
GST would be April 2017. It will take 2 to 3 years for GST to
stabilize, so benefits will not accrue immediately.
Communicating this will be essential for managing GST.
States are concerned about the loss of revenue as they fear
that the proposed national GST may encroach the State VAT
revenues.
They are also concerned about the loss of fiscal autonomy as
far as levying taxes is concerned, which is unavoidable if
there is uniformity in the rate structure of the proposed GST.
The key items of disagreements are: petroleum taxes, liquor
39
taxes, and purchase tax on food grains. To retain integrity of

Progress and Prospects for GST in India

There is also an issue concerning level of sales below which firms need
not register for GST
The GST draft Law has the following provision:
A person is liable to pay tax if his aggregate turnover in a financial year
exceeds INR 10 lakhs. However, a person conducting business in any of
the North Eastern States including Sikkim, is required to pay tax if his
aggregate turnover exceeds INR 5 lakh.
The Central Government, a State Government or any Local Authority shall
be regarded as a taxable person in respect of activities or transactions in
which they are engaged as public authorities other than the activities or
transactions as specified in Schedule IV to this Act, like activities of
issuance of passport, visa, birth certificate etc.
As compliance cost to turnover ratio curve is downward sloping, such
low exemption level employees high compliance cost to turnover ratio
for small enterprises will be high.
Lower exemption threshold for the northeastern state is particularly
inappropriate as they primarily relay small firms.
There is however provision in GST draft for funds with less than INR 50
lakh turnover to have more relax compliance requirements, reducing
40
their compliance cost.

Progress and Prospects for

GST in India
While it is legitimate for states to bargain to retain their fiscal autonomy, they should not use it to
indulge in predatory competition and export tax burden to non-residents.
Some states are taking distortive measures to increase current sales tax and excise tax revenue as
Union government has promised to compensate for any losses due to GST for the first five years. This
is not unexpected behavior.
The dilemma is that state can potentially retain flexibility in GST rates and base but the economy as a
whole will forego potential benefits, including relatively lower administrative and compliance costs of
the GST (Ramachandran 2014).
Can Indian polity manage balance between national interest and narrower political party and state
interests? This will be among the major factors affecting the net benefits (the issue is about the size
as direction of benefits is positive) from the GST.
Fiscal autonomy however need not just concern GST rates and base, but other areas. Example:
Central government Schemes such as NREGA or Food Security Act, does require state fiscal
expenditure, reducing their fiscal autonomy. So rationalization of Centrally Sponsored Schemes
(CSSs) , which ballooned to dysfunctional level under the UPA, should be welcomed by the States.
It is essential that rationale and design of GST be communicated more effectively and broadlt to the
general public as well; and a package developed to partly mitigate possible adverse impact of GST on
basic commodity prices in the short run.

41

Select References
GST DRAFT LAW

http://www.finmin.nic.in/reports/ModelGSTLaw_dr
aft.pdf

Suggested videos:
GST Need and Necessity:
https://www.youtube.com/watch?v=apM_HDGyno
c
Overview of Dual GST Model:
https://www.youtube.com/watch?v=ASuOr5sud94
GST - Overview, RNR, Open Issues by CA Bimal
Jain - https://youtu.be/pKl7jQyZ9TI
Business World, July 25,2016, Special section on
GST ON COURSE. www.businessworld.in
42