As the government hails the goods and services tax (GST) as a new miracle cure for black money, tax terror, a segmented domestic market and, of course, revenue shortage, its leaders would do well to hark back to Canada in 1993. In that year’s elections, the ruling Progressive Conservatives, which held 57% of 295 parliament seats, was trounced and reduced to two seats. What riled the voters? The economy; in particular, a messy introduction of Canada’s GST, which all other parties promised to scrap.
GST is a great tax with which to replace myriad central and state-level indirect taxes. It would boost economic growth, national integration and revenue of all levels of the government. Provided it is done right.
The way our politicians are going about implementing GST, they promise to make a hash of it. This is a serious charge to make. To appreciate its substance, we have to first understand how GST works. It is a tax on the value added to a purchased supply — whether a good or a service — before it is sold again.
Consider a hypothetical example of four stages of value addition, of which the first has no purchased inputs — collection of lac from the forest, for example — and the last is sale to the final consumer. Assume the combined GST rate is 10 per cent.
If the value addition in Stage 1 is Rs 100, sale to Stage 2 processing would load a tax of Rs 10 to the value added, and Stage 1 supplier would pay the government Rs 10 as tax. The Stage 2 processor pays Rs 110 for his input, of which Rs 10 is tax. His value addition is Rs 50. He has to load 10 per cent of Rs 150, or Rs 15, as tax on his supply to Stage 3 processor.
Of the Rs 15 he collects as tax, he claims input tax credit for Rs 10, which he has already handed over to Supplier 1, who, in turn, has credited it to the government. He pays the government Rs 5 as tax.
Stage 3 processor’s input cost is Rs 165, of which Rs 15 is tax. He adds Rs 40 worth of value and sells the product to a retail outlet for Rs 190 (Rs 150 + Rs 40) plus tax of Rs 19.
He has already paid Rs 15 of tax to Supplier 2 and so pays the government Rs 4. The retail outlet adds value by procuring, stocking and selling the supply. Suppose he adds value of Rs 30.
His selling price is Rs 220, to which he adds a tax of Rs 22. He takes credit for Rs 19 and pays the government Rs 3. The consumer pays a tax of Rs 22, which is 10 per cent of the price.
The government collects Rs 22: Rs 10 from Supplier 1, Rs 5 from Supplier 2, Rs 4 from Supplier 3 and Rs 3 from the retail outlet. With GST, the tax component in the final sale is the total tax element in the price of the product. Today, the sales tax a consumer pays is on a price that includes several layers of cascading taxes paid in the previous stages of value addition.
A Ficci study estimated that a branded consumer product could contain a tax element nearly 40 per cent of its price. GST would eliminate that and bring total tax transparency.
But for that to work, there should be no exemptions. GST has a built-in incentive to comply: only if you collect tax from your customer can you claim input tax credit. Since your customer will claim input tax credit, you cannot but pay the government the tax you have collected.
Exemptions disrupt the chain and load tax on tax (if a price includes tax on which no input tax credit can be availed, such as on diesel).
Bye, Unified Market
Exempting a product from GST will not rid it of the tax burden it carries on its inputs. Take packs of biscuits. Unless the flour mills, paper manufacturers, printers, sugar factories, oil producers, advertisers, transport service providers, electricity utilities and all other suppliers of goods and services that have gone into its manufacture and distribution have been exempt from GST as well, the biscuit packet in the retail outlet will carry accumulated tax.
Since the retailer has to pay that built-in tax, he will recover it in his final price. Only the tax on the retailer’s value added would be avoided. Can the GST Council fix or cap the combined central and state GST rate? It cannot.
Its decisions are only recommendatory. The states have the right to legislate state-level GST rates. This constitutional right is not being taken away by the 122nd Amendment that has now been passed.
Parliament cannot fix a peak combined rate, as it cannot legislate on a state subject. Assorted exemptions mean that there will be no unified market.
States will maintain border check posts that will examine every consignment for exempt goods. Exemptions also break the automatic audit trail that GST generates to both production and associated income.
A flawless GST that covers alcohol, petroleum products and real estate can work fiscal magic. The one that is afoot will create a compliance nightmare, especially if the proposal to tax interstate consignment transfers of services, as well as of goods, becomes part of the law.