Recently Goods and Services Tax (GST) has been in the headlines. It was after the announcement made by Finance Minister Arun Jaitely in his budget speech that GST would be implemented by next fiscal year.  It might be useful to begin by quickly summarizing the business case for GST.

The GST is a tax reform that has been on the cards for more than a decade. In principle, it is the same as the Value-added Tax (VAT) — already adopted by all Indian States — but with a wider base. While the VAT — which replaced the sales tax — was imposed only on goods, the GST will be a VAT on goods and services.

In the current tax regime, States tax sale of goods but not services. The Centre taxes manufacturing and services but not wholesale/retail trade. The GST is expected to usher in a uniform tax regime across India through an expansion of the base of each into the other’s territory. This is why a constitutional amendment was necessary — to give concurrent powers to both the States and the Centre to make laws on the taxation of goods as well as services.

Not surprisingly, the economic arguments trotted out in favour of the GST are basically the same as were given two decades ago for the introduction of VAT. These are twofold.

Goods and Service Tax
Goods and Service Tax

Positive Aspects

First, the GST, by subsuming an array of indirect taxes under one rubric, will simplify tax administration, improve compliance, and eliminate economic distortions in production, trade, and consumption. Second, by giving credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer, it avoids the ‘cascading’ of taxes, thereby cutting production costs, and making exports more competitive. According to the Union Finance Minister ArunJaitley, thanks to these efficiencies, the GST will add 2 per cent to the national GDP.

Only time will tell whether the GST will have a positive impact on the GDP or not. But there is one thing the GST will not have a positive impact on: the States’ fiscal, and therefore, political autonomy.

Loss for the States?

Things don’t look all that dire on paper. As per what’s being referred to as the GST Bill – which is actually the Constitution (122 amendment) Bill, 2014 — passed in the LokSabha last month, India will have not a single federal GST but a dual GST, levied and managed by different administrations. The Centre will administer the central GST (CGST) and the States, the SGST. The monitoring of compliance will also be done independently at the two levels.

This is not the only limitation. The rates for both, the CGST and the SGST, will be fixed by the GST Council, whose members will be State finance/revenue ministers and chairman will be the Union finance minister. Once the rates are set by the GST Council, individual States will lose their right to tax whichever commodities they want at the rates they want.

In other words, while the loss in revenue of the States may well be compensated by the Centre (as provided for in the GST Bill), how does one make good a State’s loss of the political right to fix its own tax rates?

The shift towards indirect taxation

Around the world, governments, faced with declining tax revenues, and too fearful that higher corporate taxes will lead to capital flight, have been turning their attention to indirect taxes, which have a wider base than direct taxes, are more difficult to evade, easier to administer, and not income-dependant beyond a point.

Thus GST Reforms might prove a boon for the Indian Economy if implemented with greater autonomy to the states so that they can compensate for the revenue losses.

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