The Rajya Sabha has passed the goods and services tax bill, paving the way for the most significant tax reform since Independence. The GST is expected to simplify taxes, reduce procedural hurdles, increase the tax base, minimize tax avoidance, and bring down costs, benefiting all stakeholders. This bold step towards unifying our tax architecture to bring it in line with the world's leading economies is also critical for the government's vision of improving the 'ease of doing business' in India.
The GST has three important elements. First, it combines taxes like excise, sales and services. It is said that 17 taxes will be replaced by one, leading to ease of doing business. Second, the indirect taxes will be calculated on value addition and not on the value of the good or the service. This would remove the cascading effect of tax on tax and profit on tax. Finally, not only would the cascading effect of each of the taxes be removed, but even that across these taxes would go. This would lead to a possible fall in prices, all else remaining the same.
Once the GST gets implemented, there will be a radical transformation from a complex, multi-layered and cascading indirect tax system to a single and unified tax system that allows for tax set-off across the value chain, both for goods and services. This should help lower product costs and thereby make Indian goods competitive in comparison to imports, increasing the profitability of companies. This improvement should help achieve larger economies of scale, leading to the harnessing of inflation.
It is evident that with the onset of the GST, there will be a remarkable impact on every sector of the economy. The manufacturing sector, which has hitherto been plagued by a complex tax structure, should stand to benefit.
There will be three taxes - the central goods and services tax collected by the Centre, the state goods and services tax collected by the states, and an inter-state goods and services tax on inter-state movements collected by the Centre. Under pressure from the states, alcohol, tobacco and petroleum goods are likely to be left out of the purview of the GST. The same applies to electricity and real estate. With these categories having separate taxes, there will possibly be some cascading effect.
Since value addition is only a fraction of the value of a product, if the tax rate remains the same as before, the tax collection would fall. If the government is to collect the same amount of tax as it did in the earlier tax regime, it would have to raise the tax rate under value-added tax. This is called the revenue neutral rate, which could be pretty high. Further, tax will have to be collected at each stage of production and distribution. So, even if the tax rate is a common one, the collection of the tax will still be complex.
Services did not have to pay sales tax but will now have to pay the SGST to the states. So their prices will rise. For instance, telephone calls, insurance, transportation, restaurants and the like will become dearer. A common tax rate will imply that all basic goods prices will rise, and even if some final goods prices fall, the rate of inflation will go up.
If the rate of inflation rises, demand in the economy would fall and the rate of growth will decline. To avoid this, the government will have to give up the RNR and fix lower rates of tax. But then the collection of tax will fall and the states suffer. The deficit of the Centre and the states will rise. This is the worry of the states. If the Centre tries to compensate them for the fall in revenue, as it is promising to do, the Centre's deficit will rise even more, creating further problems.
These macroeconomic issues have not been debated. Another ignored aspect is the interest of the small-scale and unorganized sectors. The small-scale sector produces and sells locally, so it would hardly benefit from a unified market. It is being exempted from the payment of the GST. Therefore, it would not be able to claim credit for any purchase from the organized sector and would be at a disadvantage. If it sells to the organized sector, it would not be able to provide the benefit of set-off and, therefore, would have to cut prices so that its sales do not decline. A decline in the small and unorganized sector would reduce employment generation since it is an employment intensive sector.
