The ability to simplify means to eliminate the unnecessary so that the necessary may speak.Hans Hoffman
In a World Bank ranking on the ease of paying taxes, India ranks at the very bottom –172 among 190 countries. India also ranks at the very bottom in percentage of voters that pay taxes – less than 7 percent, which is the lowest among major economies. This suggests that perhaps there is a direct correlation between simplicity and tax compliance that our policy makers are missing.
Is GST the Right Step in the Right Direction?
A good example of this is the proposed Goods and Services Tax (GST). The objective of the GST is to eliminate a slew of indirect taxes with one simple tax to allow ease of interstate commerce. The 2017 Economic Survey estimates that India’s aggregate interstate trade (54 percent of GDP) is not as high as that of the United States (78 percent of GDP) or China (74 percent of GDP) largely because of the complex indirect taxation laws across states.
The GST is a step in the right direction, but unfortunately, as with most other schemes that get churned through multiple bureaucratic committees, this too has been complicated to the point that its administration and compliance will create chaos. And, when the costs to administer and comply far exceed the benefits from GST it will create doubts regarding its value.
More than 160 countries use a GST or VAT tax and so the principles that make it effective have already been laid out. Despite this body of evidence, it is inexplicable why the Indian government and the bureaucracy decided to mimic that which does not work.
Also Read: Get GST Going, Improve It Later
Multiple Rates Difficult to Implement
The biggest problem with the proposed GST is multiple tax rates – six different rates for different industry groups. Basic foodgrains are zero rated, meaning taxed at 0 percent; mass consumption products like spices, mustard oil etc will be taxed at 5 percent; processed foods etc at 12 percent; soaps, oil, toothpastes, smart phones, computers, etc at 18 percent; white goods and cars at 28 percent; and all luxury goods including luxury cars at 28 percent plus a cess which may take the total tax to 40 percent.
We know from the experience of other countries that the single biggest reason for a GST tax structure to fail is poor administration. Multiple tax rates guarantee poor administration. Ghana introduced GST in 1995 with three different rates but soon abandoned it since it became too complicated to implement.
China had a similar experience, and it too eventually rejected multiple rates in favour of a simple policy with one single rate across all industries.
Problems With Six-Tier Rate
A GST with multiple rate structure requires firms to keep separate records for different purchases. Even the simplest GST with a single rate (plus zero rate and a few exemptions) requires at least 9 pieces of information from each taxpayer (the value of supplies at the two rates and the value of exempt supplies, the value of purchases at the two rates, two liabilities to VAT on output, and two liabilities to VAT on inputs).
Six different rates will require at least 25 pieces of information. Not only will this increase compliance and administrative costs, it will increase the cost of auditing (more records to be checked; more incentives and opportunities for firms to misclassify goods).
According to the IMF and the World Bank, the most effective way to structure a GST/VAT tax is by having a single rate across all products with a zero rate granted only to exports. This ensures simplicity and prevents one group from having an unfair advantage over another. The majority of countries (82 percent) that have introduced the GST/VAT-type tax apply a single-rate structure, largely because it is fair and easy to administer.
The GST in New Zealand, widely regarded as the most efficient in the world, has a single standard rate of 12.5 percent across all industry groups. None of the 160 or so countries that use a GST-type tax have six different rate structures: India would be the first. It is perplexing why the Indian government chose to start with something so complex.
Exemptions Won’t Help Expand the Tax Base
The proposed GST scheme is riddled with another complexity – exemptions and zero rating. All foodgrains, for example, will be taxed at zero percent, and while it may appear to be a well-intentioned attempt to provide tax relief to the poor, it will needlessly complicate the administration of GST and add materially to costs. Exemptions violate the very idea of the GST to broaden the tax base so that tax rates can be lowered and compliance increased.
Under the proposed GST, almost half the base will be either exempt or taxed at a very reduced rate. One thing is for sure; over time politics will creep into deciding which industries to exempt resulting in lower revenues and further distortions in rates across industries.
It would be better for the government to provide a direct rebate of the tax on expenditures to each low-income family. This would be a more neutral, and a less distorting way of providing tax relief to the poor than exempting entire categories like food and clothing from tax. In order to keep the GST simple, it should be applied equally to all goods and services, without any exemptions.
Dual Administration Will Increase Paperwork
The other complexity in India’s proposed GST is dual administration. The tax will be collected both by the Centre and the state, and administered through a complex web of offsetting credits. A diverse company doing business in all states could potentially face six different tax rates across 28 states. Besides the burdensome paperwork this would entail, there is the issue of timely refunds.
Multiple tax rates, exemptions, cross-border state refunds and the reluctance of cash-poor governments to return taxes received, will delay refunds for companies and affect cash flows and working capital requirements. The problem will be particularly serious for exporters for whom a huge backlog of refunds will adversely affect pricing in an already competitive global market.
The government would be well advised to simplify GST so that its ability to promote greater interstate trade and broaden the tax base would lead to revenue enhancement. A single rate across all industries, with no exemptions, and a single source for administration, collection and refunds will go a long way in making the GST the “game changer” it is intended to be.
Otherwise, it could be another tax boondoggle that increases administration and compliance costs, and hampers investment and growth.
(The writer is Managing Director, Centre for Environmental and Economic Policy. He can be reached @SanjivbDr. This is a personal blog and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)