The Model GST Law makes it clear that the proposed Goods and Services Tax (GST) regime would have imperfections and anomalies to begin with. For instance, input tax credit on capital goods would not be available for most sectors like transportation, construction and infrastructure. It follows that there would be no ‘seamless and efficient’ crediting of taxes paid, to avoid tax-on-tax and cascading rates, as called for by the Arvind Subramanian Committee last year. But no matter. The GST regime now in the works would be better designed and ‘clean’ than is usually the case abroad. Now, over 160 nations have some form of value-added tax (VAT), which is what GST is. The idea, of course, is to reform the indirect tax structure, with tax payable only on the value-added at each stage of output or delivery, and input tax credits available for taxes already paid.
But as the Subramanian panel report noted, the tax regimes abroad tend to be either overly centralised, depriving sub-national levels of fiscal autonomy (as in Germany). Or, where there is a dual structure, they are either administered independently thus creating too many differences in tax bases and rates, which weaken compliance and make inter-state transactions rather difficult to tax (as in Brazil). Or where they are administered with a ‘modicum of coordination’ that somewhat reduce the disadvantages but do not quite do away with them, (for example, dual VAT in India today).
The long-pending GST legislation provides for a common tax base and common or similar tax rates, for the Centre and states, which would facilitate administration and compliance, including for inter-state transactions. It would also provide leeway and fiscal autonomy for the states.
However, in the Model GST Law, Chapter 5 on input tax credit, makes it abundantly clear that the current system of denying tax offsets for capital goods in most sectors will continue going forward.
In the current system of dual VAT, while the central excise duties and state VAT applies to all capital goods, input tax credits are essentially limited to manufacturing plant and equipment. And further, no input tax credits are allowed for the excise duties on capital equipment acquired for use in such sectors as logistics, distribution, construction and infrastructure. What is the extent of the blocked input taxes?
The Subramanian Committee report estimates for 2014-15 investment in equipment and capital goods in the non-government and non-household sector to be about Rs 7.4 lakh crore. Input tax credits were blocked for as much as three-fourths of the total investment, or nearly Rs 5.5 lakh crore for that year. It is one reason why India remains a high-cost economy with manifold rigidities and inefficiencies.
The lack of input tax credit on capital goods in most instances effectively makes attendant goods and services dearer by at least 12-14 per cent, which implies high, cascading costs across the board.
Canada, according to the report, had a similar excise duty regime prior to adopting GST. Studies suggest that providing seamless input tax credit on capital goods has been beneficial to Canada to the extent of 0.5 per cent of GDP. And given that the extent of tax cascading is higher in India, seamless input tax on capital goods here would surely lead to benefits higher than 0.5 per cent of GDP, assuming a capital-output ratio of 4.
Alas, that is not to be as per the Model GST Law. Yet the best need not be the enemy of the good. A GST, despite imperfections, would lead to much more efficiency, transparency and tax buoyancy. Hopefully, there will be more seamless input tax credit available on capital goods across sectors gradually, especially if depreciation claimed as per the Income-Tax Act is duly factored in.
Besides, ‘sin’ goods like tobacco items, taxed by the Centre, and potable alcohol, taxed by the states, would remain outside GST, as would petroleum products, for now, which are taxed by both the Centre and the states. It does make sense to include petrogoods in the GST, with provision for additional top-up taxes. But we need to modernise and broaden the indirect tax base and not overtly rely on such products for revenue.
However, a cap on the GST rate need not be put in the constitutional amendment Bill, which would be difficult to change. Looking ahead, the proposed GST Council needs to be duly empowered to revise the rate structure and also decide on the mechanism for dispute resolution.
And the Central Sales tax (CST) for inter-state sales, now 2 per cent, needs to be reduced to 1 per cent and done away with in no more than two years. Then, originating states need not be compensated for 2 per cent CST for five years.