The Politics of GST

While GST implementation will revolutionize taxation in India, it will also upend power hierachy in the tax bureaucracy, fiscal federalism and corruption template

The goods and services tax (GST) juggernaut has now begun its journey and there is no looking back. The new tax system promises to revolutionize life for the entire value chain starting from goods and services producers all the way to consumers. But the GST also promises to upend many other established systems—such as the power hierarchy in the tax bureaucracy, the known fiscal federalism model and the prevalent corruption template. These changes, in turn, will dictate the final shape of the new tax regime.

The first signs of impending trouble can be found in the notification regarding the GST council. The press release announcing the creation of a GST council, under the provisions of the Constitution (101st Amendment) Act, 2016, states the council will be chaired by the Union finance minister, with his junior minister and finance ministers from states as members.

The fun and games begin thereafter. The secretary (revenue) in the finance ministry is the council’s ex-officio secretary, and he will be assisted by one additional secretary and four joint secretary level officers. The chairman of the Central Board of Excise and Customs (CBEC)—a body created under Central Boards of Revenue Act, 1963—has been reduced to a permanent invitee.

This has set in motion a power struggle between officers from the Indian Revenue Service (IRS) and the Indian Administrative Service (IAS) for control over the council. This is manifestly a fight to gain oversight over what will inarguably become the country’s richest financial pipeline. Although finance minister Arun Jaitley has assured IRS officers that their grievances will be heard the first round seems to have gone to IAS officers.

Similar signs of the IAS cadre inserting itself into the fiscal framework can be found in the GST Network (GSTN), an information backbone for the new tax system. The network has been set up as a not-for-profit company with shareholding from the Centre, states and financial institutions. The company’s website calls it a “non-Government, private limited company”. Both the chairman and chief executive officer’s posts are occupied by former IAS officers, as are many other board seats. Of the total 13 board members, there is only one CBEC representative.

Smooth GSTN operations will be critical to the GST’s success. A lot will hinge on registering all buyers and suppliers, calculating and crediting input tax to intermediary stage producers on time to induce more producers to register with GSTN.

Excise and customs officers have planned a series of agitations, which stretch all the way to budget day in February 2017. Interestingly, the power struggle spilled overinto the direct taxes domain in July when income-tax officers rebelled against the secretary (revenue)—this required the finance minister’s intervention.

With the oversight of the financial pipeline changing, there are no guarantees that corruption will be completely eliminated. There has been a lot of discussion on the likely corruption model that will replace the legacy structure. The earlier indirect-tax regime had many loopholes, inserted by the industrialist-politician-bureaucrat nexus. Tax experts have pointed to some gaps created at the GST’s birth. One springs from the threshold fixed for exempting goods and services from GST, Rs20 lakh, which could motivate many assessees to break up operations into an informally connected web of small units. Second, allowing states to exercise oversight over units below Rs1.5 crore annual turnover might open up another escape hatch. This is an evolving space; tax officers have already put the new code through the wringer and alerted seniors about possible loopholes.

Finally, GST has altered the fine balance of India’s federal structure by reshuffling taxation powers divided between the Centre and states in the Constitution. It is quite likely that states will attempt to regain some of this equilibrium through the GST council. The amended Act gives the council members enough powers to decide on which goods and services will be subjected to or exempted from GST, to decide the differential GST rates, and much more.

The catch is in the decision-making process. All proposals will be decided through a voting system, with the principle of one-state-one-vote. Under the voting formula, the Centre has one-third weightage of total votes cast, with the states apportioned two-thirds weightage. Any proposal needs a majority of at least three-fourths of the weighted votes cast. Assuming a full house present (quorum requirements are 50%), a Centre-sponsored proposal can succeed with 18-19 state votes.

The current National Democratic Alliance (NDA) combination rules over more than 10 states (either singly or in coalition) and has the support of three regional state governments. The fate of Arunachal Pradesh hangs in the balance. Five states—Goa, Uttarakhand, Uttar Pradesh, Manipur and Punjab—go to the polls in 2017. Another seven states will battle it out in 2018. Of the 12, if NDA manages to win six-seven, they will have enough firepower to push through proposals in the council. This gives a completely new meaning to the concept of fiscal federalism.

Intense politics preceded the birth of GST. But it would be a mistake to think that only good economics will henceforth guide the remaining workload to get GST off the ground. The real politics starts only now.

This article originally appeared as part of my column, General Disequilibrium, in Mint on October 19, 2016. It can also be read here.

Key GST Lessons From The World

The long march to implement the long-awaited Good and Services Tax in India has just begun. It is instructive to understand how other countries introduced this tax and cherry-pick lessons from their experiences

As India gets ready to celebrate the 70th anniversary of its independence, it is also preparing for another important milestone. Great hopes have been pinned on the Goods and Services Tax (GST), which will liberate Indian citizens from the tyranny of multiple levies and tax rates. This tax will unite almost all state and central indirect taxes into one single category, thereby creating a true single market in the country.

The passage of the Constitution (122nd amendment) Bill on 3rd August in the Rajya Sabha marks the crossing of the first hurdle in implementing the transformational GST regime. However, there is still substantial legislative work to be done – apart from the amendment (which will now travel to the Lok Sabha, the President’s office and state assemblies for ratification), Parliament will have to vote in two further bills to make GST a reality.

Beyond the legislative workload, Indian administrators and businesses will need to do their homework before this reality sets in. There are approximately 140 countries in the world that have introduced GST (also called VAT, or Value Added Tax), and there are manifold lessons to be drawn from their respective implementations.

Malaysia was the most recent country to implement GST in 2015, having announced its intention to do so in 2009. Malaysia’s experience highlights how inadequate preparation can hamstring the tax’s speedy implementation from the outset.[i]Malaysian businesses and tax authorities had a harrowing time adjusting to the new system, which was riddled with uncertainties and teething problems. The Malaysian government had to contend with street protests by small businesses and traders who were confused by the new system—whether in calculating the correct value-added rates, or in seeking tax credit refunds. Unsurprisingly, opposition political parties found it opportune to fish in these troubled waters, adding to the government’s mounting operational woes.[ii]

There was another layer of complexity. Malaysia had a multiple GST rate structure, much like the one proposed in India. A 6% GST (among the lowest in the world) was introduced, with some essential goods exempted and some goods attracting a zero rate i.e they were not exempt and could be taxed later. India too has proposed a multi-tiered structure, which will be finalised by the GST Council whenever it is set up.

Two clear lessons emerge from the Malaysian experience. Under pressure to launch GST as soon as possible, the Indian government must resist temptations to truncate the implementation process, which will include the training of tax officers and business executives. A presentation by revenue secretary Hasmukh Adhia estimates that 60,000 tax officials in both central and state governments will need to be trained.[iii] GST is a tectonic shift in the indirect tax architecture: the point of taxation shifts from producers to consumers, requiring a significant reorientation in philosophy and perspective. This overhaul cannot be completed unless the technology backbone is in place and all the relevant economic agents are registered. That alone is a mammoth task. There should, therefore, be no compulsion to implement GST by April 2017 if either the system is not fully tested or all the pieces are not firmly in place.

A related issue almost tripped up Malaysia’s GST experiment: the timely payment of input tax credit refunds.[iv] Unless the necessary technology infrastructure is installed, it can take months to refund tax credits, thereby creating cash flow problems for all links in a supply chain. This can easily convert GST supporters into detractors. Delaying tax credit refunds leads to protracted litigation and provides perverse incentives for the supply chain to stay outside of the organised system.

A second set of lessons can be drawn from Singapore. The city-state introduced GST in 1994 but witnessed a sharp rise in inflation soon after its introduction, mirroring the experience of many other countries.[v] Although inflation rates tend to moderate after a couple of years, the Indian government must be prepared for an initial surge because of India’s unique supply-side pressures, which tend to firmly embed inflationary expectations in households and businesses. India can consider what many countries did: initiate anti-profiteering measures at the retail level to protect consumers from price gouging.

Subsequently, the Singapore government faced other predicaments, like t the need to increase GST rates without stoking inflationary pressures. Eventually Singapore did increase GST rates (from 3% in 1994 to 7% currently), but simultaneously cut income tax rates (both at the individual and corporate levels) and accelerated the delivery of welfare benefits to lower income sections.[vi] While GST is efficient, it can also be regressive, especially for low income workers or pensioners. The Indian government therefore needs to be cognisant of this, and act cautiously.

The final set of lessons come from Canada, which introduced GST in 1991 amidst great internal conflict and disagreement. In fact, at the tax’s introduction, three provinces–Alberta, Ontario and British Columbia–even sued the federal government for violating constitutional agreements and limits. But over the years, Canada has pioneered a unique system that allows for three different models to co-exist.[vii] [viii]For example, Quebec is permitted to administer its own value-added tax alongside a federal GST. Quebec is responsible for all tax administration in the state, independently determining its tax base, independently fixing the state VAT rate, and even remitting federal GST collected in the state to the central government for a fee.

Compared to Canada, India has been able to forge a broad consensus among most states through a process of negotiation and compromises. The only point of disagreement remains the GST rate, which has been entrusted to the GST Council. This may lead to intense political manoeuvring with demands for special status or special rates. Tamil Nadu has already expressed its dissatisfaction with GST.

These examples clearly illustrate that the GST battle has barely begun: there are many mountains to climb, and multiple fires to extinguish along the way. The process of bipartisan consultation and consensus-building with states and various stakeholders must continue to make GST a cornerstone of successful and sustainable fiscal federalism.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References

[i] Pachisia, Vivek; Lessons from countries that have implemented goods and services tax; Financial Express; July 28, 2016;http://www.financialexpress.com/economy/gst-lessons-from-countries-that-have-implemented-the-goods-and-services-tax/331289/

[ii] Dey, Sudipto; Some Lessons From Malaysia That India Can Use; Business Standard; New Delhi; June 13, 2015; http://www.business-standard.com/article/economy-policy/gst-some-lessons-from-malaysia-that-india-can-use-115061300748_1.html

[iii] Adhia, Hasmukh; Goods and Services Tax: Next Steps; Department of Revenue, Ministry of Finance, Government of India; New Delhi; August 4, 2016;http://finmin.nic.in/press_room/2016/GST_nextstep_04082016.pdf

[iv] Beh, Yvonne & Tan Yi Lin; GST In Malaysia: One Year On; Wong and Partners; April 2016;http://www.wongpartners.com/files/Uploads/Documents/Type%202/WP/al_kulalumpur_gstmalaysia_apr16.pdf

[v] Ilias, Suhaimi with Zamros Dzulkafli, Ramesh Lankanathan and William Poh; Malaysia: GST- Early Impact Assessment; Maybank KimEng; April 2015;http://info.maybank2u.com.sg/pdf/investment-insurance/misc/misc-15-04-15-3.pdf

[vi] Singapore Government; How Is the Government Helping to Mitigate Inflation in Singapore; December 14, 2012; https://www.gov.sg/factually/content/how-is-the-government-helping-to-mitigate-inflation-in-singapore

[vii] Kumar, Sanjay with ML Sukhpal, Sandeep Rawal, Ashok Kr Pandey, Samar Nanda; Policy Paper on Role of Central Board of Excise and Customs in GST; National Academy of Customs, Excise and Narcotics;http://nacen.gov.in/inspire/uploads/downloads/569887ea212d1.pdf

[viii] Sharma, Radheshyam with JK Simte, MK Sarangi, KGVN Surya Teja, Sydney D’Silva and Manish Thapliyal; How to achieve administrative harmony between centre and states in the GST regime; National Academy of Customs, Excise and Narcotics; January 6, 2016;http://nacen.gov.in/inspire/uploads/downloads/56989a961d524.pdf