A regime too patchy

Ehtisham Ahmad

Exemptions under the GST undercut its main advantage — preventing the cascading of taxes.

Late last month, the empowered committee of state finance ministers met in Shillong to discuss the goods and services tax (GST). It asked the Centre to keep taxes on petroleum products, liquor and entry of goods out of the GST's ambit. It also asked the Centre to devise a constitutional framework to compensate states for any loss of revenue due to the introduction of the GST.

The old excise-based tax system in India leads to a cumulative effect of taxes on inputs multiplying the taxes on outputs, which cascade through the economy and add to the cost of production, thereby disadvantaging exports. Under a proper GST, this cascading would be removed, and exports would be free of taxation. This will not happen in India if certain goods are exempt from the GST (so that states can levy their own taxes on them). Exemptions do not permit taxes on inputs to be fully offset against those on outputs. The proposal for a unified authority to implement an integrated GST makes perfect sense in an increasingly competitive world.

With the economic crisis, many European countries have moved towards the value-added tax (VAT) framework, which does not discourage exports. In China, the centrally administered shared VAT is rapidly replacing provincial business sales taxes on key services such as transport and telecom. Substantial reductions in the tax burdens of firms have been demonstrated as a result, improving the competitive position of the economy.

India has suffered due to the continuation of the colonial system, which split the main tax bases between various levels of government. This severely handicapped the design and implementation of a GST. As Satya Poddar and I had argued in a submission to the last Finance Commission ("GST Reforms and Intergovernmental Considerations in India"), the Indian GST has three main disadvantages. First, the distinction between goods and services is becoming increasingly untenable. Second, cascading emerges due to exemptions and gaps in tax bases. This vitiates the GST's main advantage. Third, complexity is a serious drawback. Multiple administrations increase the burden of compliance on companies and traders.

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