Double-edged sword: High initial GST rate may make most services costlier

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by R Jagannathan (www.firstpost.com)

For those who believe that the goods and services tax (GST), touted as the biggest single tax reform since independence, is going to be a breeze once it is legislated, here is a sobering thought: it will push up costs in the economy in the initial phase.

The bill for the introduction of GST was tabled by Finance Minister Arun Jaitley in the Lok Sabha last December, but the house is yet to take it up for discussion and passing. It could happen in the ongoing budget session, but before it becomes law, not only will the opposition-dominated Rajya Sabha have to pass it, but half the states too must do so since it is a constitutional amendment bill (122nd Amendment Bill).

But even after the legislative hurdles are crossed, GST will be a double-edged sword. The two big bumps on the way will be the IT infrastructure to handle GST, and a decision on the actual “revenue-neutral” rate that will be adopted as the initial GST rate. A revenue-neutral rate is that rate at which government revenues (both centre and states) are not impacted positively or negatively by GST.

Of the two hurdles, the GST rate adopted has the potential to push costs up since the big change will be in services – which are the biggest part of the economy, accounting for nearly 60 percent of GDP. As things stand, the revenue-neutral rate being talked about right now is in the range of 25 percent, whereas service tax is currently levied at 14 percent. According to a report in The Economic Times today (21 April), the jump could be more than 10 percent in service tax – a potential all-round inflation booster – unless the government decides to apply the service tax to only a part of the price of services.

The GST will impact services more negatively than goods because unlike manufactured products, where the final GST payable can be reduced by setting off the GST already paid on components and inputs, in the case of services, the setoffs are low. If you are paying a GST of 25 percent on a car, the full impact will be far lower since the GST paid on the components will bring down the effective final GST rate.

However, in the case of services, the setoffs are lower. For example, when you are levied 14 percent service tax on your phone bill or credit card charges, there is no real set-off that the phone or card company can bank on to reduce your bill. There are no inputs constantly going into the production of such services, beyond manpower and infrastructure. So if the revenue-neutral rate is really 25 percent, your mobile bills will really rise by close to 10 percent from current levels.

Freelance journalists, consultants of every kind, lawyers or management gurus will have to charge a hefty 25 percent service tax for their clients.

This means the fastest growing segments of the economy, and the government fastest-growing revenue source (service tax) will both face speed-breakers.

Over the last five years, service tax revenues of the central government have risen more than three-fold, from Rs 71,000 crore in 2010-11 to this year’s budget estimate of over Rs 2,09,000 crore. Excise has risen only half as fast – from Rs 1,38,000 crore to Rs 2,29,000 crore.

Now, if GST gives the biggest blow to services, it is bound to slow down the fastest growing segment of the economy – and the government’s most important cash cow of the future.

The GST will impact short-term inflation trends in two ways: one, by forcing input suppliers to start paying tax, hitherto untaxed segments will come into the tax net, resulting in an upward move in prices. The sharp spike in service tax will be the other inflation booster.

This does not make the GST a bad tax, since one of the main goals of GST is to prevent tax evasion and make the tax collection process easier. Over time, GST will boost economic efficiencies and the higher revenues will reduce the potential for bribery and harassment at all ends. Inspector raj will ease.

But no one should think that GST comes without a bunch of immediate problems. The cost-push bump is one issue we will have to handle upfront.

GST is meant to replace excise, state value-added taxes, entertainment tax, octroi, entry tax, luxury tax and purchase tax on goods and services. What will be out of the GST net will be booze, petrol and diesel, though the latter two may be brought in at a later date.

GST in the initial phase will be a double-edged sword.

Source: TheFirstPost

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