GST- Best cannot be the enemy of Good

The Government Amendment Bill for the Goods and Service Tax was introduced in Lok Sabha on 19 December, 2014. Earlier it had been considered by the Parliamentary Standing Committee which submitted its report in August 2013. This is one of the key reform initiatives which commenced during the earlier NDA Government was pursued during UPA I and UPA II. It continues to be a centre piece of our tax reforms. The Finance Minister after an introductory statement on 24 April, 2015 requested that the bill be taken up for discussion and enactment. Congress members and some regional parties objected that the Amendment introduced subsequently after taking account of earlier recommendations of the Standing Committee needed further discussion. They wanted it to be resend to the Standing Committee. This would have delayed this bill for much longer.

In essence India still remains a fragmented market. The varied rates of taxes imposed by Centre and States create cascading effect, burden the consumers, deprive government of tax revenue, add to the onerous of compliance and reduce the competitiveness of manufacturing.

The Essence of the Amendment Bill lies in subsuming various Central and State indirect taxes including central excise duty, service tax, countervailing duty, state value added tax, octroi, entry tax, luxury tax among others. The Bill aims at creating a single unified national market for goods and services sans of tax distortions. A GST Council will also be constituted. The membership of the council comprises of the Union Finance Minister, the Union Minister of State incharge of Revenue or Finance and the Minister incharge of Finance and Taxation or any other nominations by State Governments.

The functions of the council include making recommendations on taxes, surcharges and cesses to be levied, goods and services to be included or exempted and so on. The council will model laws and principles governing GST and decide upon the turnover below which GST can be exempted. It will also decide floor rates and bands of GST. It will suggest special rates to raise additional revenues during natural calamity. The Council would also design special provisions with respect to 10 states including Jammu and Kashmir, Himachal Pradesh and North Eastern States.

Implementation of GST would have some clear advantages for the economy.

First, a single comprehensive tax benefits all stakeholders.  Consumers will benefit by paying one tax in place of multiple overlapping taxes like VAT, entertainment tax etc., leading to market distortions. Revenue benefits from the broadened tax base. The suppliers benefit from the minimal burden of tax levied only on the value added by them.

Second, it creates a unified common market. The cascading effect of complex indirect taxes is mitigated. The transparency and simplification improves compliance.

Third, a comprehensive tax improves the competitiveness of manufacturing sector. In the long run, by promoting growth it improves the per capita income. The purchasing power of the growing middle income population of India is enhanced.

Fourth, a transparent and rational tax regime improves the Ease of Doing Business. It boosts investor confidence, encourages capital inflows and gives a fillip to the Make in India programme.

Multiple challenges, however, remain unresolved.

One, states are concerned that a substantial proportion of their indirect tax revenues are now subsumed in one tax. They are also worried that now the tax revenue will accrue to the destination states and not the manufacturing states. Central government’s decision to reimburse the loss in revenue will allay this fear. In the long run, higher growth would make central support unnecessary. The transitional fiscal burden on the central government will also be allayed.

Two, the rate of GST also remains undecided. Tax rates cannot be too low as it will impact Government’s revenue. On the other hand, high tax rates will affect compliance. Our tax rates, in the long run, need to be aligned with the rates in other developing economies.

Three, issues such as taxing inter-state transactions at 1 percent has caused concern. It has been decided that such a tax with an upper limit of 1 percent be collected by the Centre and can be assigned to the States for an initial couple of years. The GST Council reserves rights to make recommendations in this context. However, a higher rate of such tax can create production distortions.

Four, the exclusion of tobacco, alcohol and petroleum and the real estate sector robs major areas from a unified tax structure. Overtime and given experience, the GST Council can phase these in.

Analysts believe that GST is central to our growth strategy. While estimates vary, many believe that it can add upto 1.5 percent to India’s GDP. It benefits all stakeholders. The glitches have to be resolved overtime. The Best should not become the enemy of the Good. An early GST is now an economic necessity.

End of Neo-Colonialism

The babel around the Budget and the XIV Finance Commission and subsequent comments and analyses have now ebbed. There are some States and stakeholders who are critical based on inadequacies of allocation in the social sector. But there is a consensus that the Budget represents a credible balancing act and gives a decisive momentum to the economic upturn which has already commenced. Thomas Sowell has said “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” So which lesson did the Budget pursue?

In retrospect, there were some overarching policy options to leverage that the Finance Minister had.

One, the classic choice: growth versus inflation. How much of fiscal flexibility was acceptable to enhance public outlays in infrastructure – railways and highways? The budget has adhered to the path of fiscal rectitude by meeting the fiscal deficit target of 4.1% this year.  It has postponed the terminal fiscal deficit target of 3% by an additional year with somewhat higher intermediate targets. The rating agencies prefer a closer adherence to the fiscal roadmap.  Of course the new time path must be adhered. I have for long argued that parliamentary approvals must be ex-ante than ex-post. The recommendation for a Fiscal Council contained in the Finance Commission’s recommendations is sensible.  This along with the new Monetary Policy Framework Agreement between the Finance Ministry and the Reserve Bank of India would act in congruent ways. It will ensure harmony between monetary and fiscal policy and thus Mint Street and North Block.

Two, subsidy rationalisation. There are significant gains in rationalising petroleum and fertilizer subsidies by de-regulating petrol and diesel and moving over to the Aadhar based LPG subsidy.  Further action is needed on fertilizers, particularly Urea. There must be pari-passu progress as JAM (Jan Dhan-Aadhar-Mobile) gathers momentum.

Three, congenial external environment to be harnessed. Oil prices have dramatically declined from $82 to $59 with soft commodity prices. The current account deficit is acceptable even though in the long run sluggish export behavior needs innovative action beyond conducive exchange rates.  We could have used this opportunity to create greater fiscal space for the future. Public debt could have been retired or a Consolidated Sinking Fund for amortisation of debt created. The Finance Commission suggests this can “tide over, roll over risks and the weak cash management practices.”. A middle path has been preferred. Substantial benefit has been passed to the consumers enhancing their purchasing power, allowing oil companies to recoup some losses and raise revenues to meet fiscal targets. Given the opportunity, this must be pursued.

Four, the XIV Finance Commission’s recommendations. There is overwhelming precedence that on devolutions they have been treated as awards than recommendatory. Consequently, total devolution to the States is now 62% of which 42% is from common divisible pool of taxes. The rise in tax devolution to States and the Non Plan grants to local bodies together represent a sharp cut of ’206292 crore from the Centre’s resource block. In the shrunken resources for the Central government the funding pattern of schemes has under gone a structural shift.  The Budget at a Glance again highlights the middle path. It classifies public outlays in three categories – schemes to be supported by the Union,  schemes to be continued with change in sharing pattern and those fully de-linked from Central support. The major flagship programmes of the government remain in the Union list like the Sarva Shikaha Abhiyan, MGNREGA, Pradhan Mantri Gram Sadak Yojna. There are others which would be financed with a changed sharing pattern. Schemes de-linked from Central support, leaving it for the States to decide are rather small. The most contentious being the Backward Region Grant Fund to Bihar, KBK and Bundelkhand.

There has been misplaced criticism that social sector outlays have been drastically pruned.  In making such comparisons a methodological error has crept in.  Analysts have compared the Budget Estimates of 2014-15 with the Budget Estimates for the current year. Those familiar with public finance know that normally the comparison is between the RE (Revised Estimates) with BE (Budget Estimates). Such comparison would suggest that allocations have been kept more or less intact. In the case of Integrated Child Development Scheme (ICDS) the reduction is sharp, but the pattern of funding is yet to be decided.

Thus the Budget and the Finance Commission are two sides of the same coin. It emanates from the design and conception of a new financial architecture of Centre-State relations. It is a giant step in promoting federalism where much larger untied resources become available to the States for selecting, designing and implementing programmes best suited to their needs. The Government had little option given the shrunken envelope after accepting the Finance Commission’s recommendations.  After all you cannot have the cake and also eat it. States cannot have both the cake of large untied resources and eat the Centrally Sponsored Schemes as originally conceived.  One can argue of whether this was the best approach or could the recalibration have been somewhat different? 

Will this new model of Fiscal Federalism work? There are inherent risks but also existing opportunities for Team India. The risks are well known if the State Governments act irresponsibly or promote fiscal profligacy. But in the end, the Government at the Centre and the States are judged by the improvement and development of life quality by the Electorate whose periodic mandate they seek.

The new fiscal architecture eliminates the form of neo-colonialism like what Rudyard Kipling described as the White Man’s Burden  viz. the Centre knows what was good for the States. A new social compact between the Union and the states has been ushered.

Thus, the adoption of the XIV Finance Commission’s recommendations and the Budget reflect that the Government has accepted both, the first lesson of economics and the first lesson of politics. A credible balancing act is what the budget is all about.

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