The Looming Disruption!!

Taxation of goods and services is one of the most vexing problems of late capitalism. These taxes lead to both an inflationary push and a distortion of the market mechanism. However, given the fact that laissez faire free market capitalism left to its own devices tends to collapse, there is a need for the capitalist state to step in both to regulate the destructive profit making logic of capitalism and also to boost demand through investments mainly in infrastructure and military spending and in providing public services and social safety nets. All this cannot be done without taxes and so they are there along with a huge bureaucracy involved in garnering these taxes.

Taxes are of two kinds – Direct and Indirect. Direct taxes are those that are levied on the income earned by individuals and corporations while indirect taxes are those that are levied on goods and services produced in the country and imported from abroad. Generally Direct taxes are said to be progressive because their incidence is greater on those with higher incomes. Indirect taxes are paid by all at the same rate when they purchase goods and services from the market, regardless of their income and so are deemed to be regressive as they put proportionately a greater burden on the poor. Also due to their inflationary and market distorting character indirect taxes are less welcome than direct taxes. However, since direct taxes alone cannot garner all the revenue required to run the capitalist state, especially in developing countries like India, where for a variety of reasons the direct tax base is comparatively small, indirect taxes have to be levied.

Over the years since independence, as the production of goods and services expanded, the indirect tax structure became very cumbersome not only with a plethora of different taxes for various goods and services but also an almost similar number of exemptions, surcharges and cesses. Matters have been complicated in India by its federal political structure wherein the states and centre tax the citizens separately and so the indirect tax structure became extremely complicated leading to huge problems in tax administration and large scale tax evasion and avoidance. Indeed the evasion of indirect taxes leads to concealment of income and so adversely affects direct tax collection also. Consequently over the past two decades there have been efforts to simplify the indirect tax structure to make it both more simple and more bouyant with the introduction and then refinement of the value added tax. The latest in this tax reform process is the impending implementation of the new Goods and Services Tax (GST) to be levied on goods and services produced within the country. It is being claimed by the Government that this will significantly ease the problems of tax administration and also smoothen and expand the economy as popularised by the slogan – one country, one tax and one market. Let us critically analyse whether this will indeed be the case.

The cardinal principle of indirect taxation is that it should have ideally just one rate or at the most two, regardless of the nature of the goods and services to be taxed. This is because the moment there are multiple rates, the scope for lobbying and litigation to decide which goods and services fall in which category increases and tax administration becomes complicated and costly. Any benefits that are to be provided to any sections of the citizenry for various reasons should not be through differential indirect taxes and exemptions but through subsidies to the parties concerned. Any restrictions that have to be imposed on the sale of particular goods and services which are harmful, like cigarettes and pan masala, can be done by imposing higher income taxes on the profits of firms producing them rather than by higher separate indirect taxes on their sale which will have the same effect of pushing up the prices of these goods to discourage people from buying them. In this way the lobbying is deflected away from tax imposition towards the provision of subsidies as it should be and indirect tax related litigation, which now clogs the courts of this country, is avoided altogether and there is very little distortion of the market due to taxation. The huge bureaucracy that is presently involved in indirect tax administration with its attendant costs, thus becomes redundant and can be gainfully redeployed to ensure higher direct tax compliance. Moreover, since tax evasion and avoidance become near impossible in a single indirect tax regime it becomes extremely difficult to conceal incomes and so the direct tax base and volume too increases substantially.

However, the problem in India's case is that it has a legacy of a huge number of rates, exemptions, cesses and surcharges and a federal political structure wherein the states and centre both have fiduciary powers to tax the citizens separately. The states, moreover, have much more limited fiduciary powers as compared to the centre and so are always constrained for resources and at present heavily in debt and sorely dependent on central grants. Since the central grants come in small tranches and late, the states are reluctant to give up whatever little fiduciary powers they have, especially the right to tax the sale of their three highest revenue yielding goods – land, petroleum products and liquor. Consequently, the GST as it stands today not only has four slabs of 5, 12, 18 and 28 per cent for various kinds of goods and services but also a special rate for Gold at 3 per cent and land, petroleum products and liquor have been kept out of its ambit altogether, allowing the states to continue to tax them at their will. Some goods like food produce of agriculture have been exempted from indirect taxes altogether. Moreover, there are various cesses and surcharges and so effectively there are more than ten rates. Also, given the States' reluctance to give up their tax collection powers, businesses operating at a national level will have to register and pay tax in each of the states in which they sell their products thus considerably increasing the compliance burden and attendant costs. Thus, the claim that the new GST regime will be a simple one tax one is an out and out falsehood.It is slightly simpler than what prevails currently but it is not simple in itself!!

The reason that is being advanced for having different rates for different goods and services is that these goods and services are used by different categories of people and so to reduce the burden of taxes on mass consumption items like food which are a major component of the expenditures of poor people these should be either exempt or have low rates. But this is a false logic and in effect leads to complications which result in higher costs for the people resulting from tax evasion and higher tax administration costs. As I said earlier, any benefits that need to be provided to the poor or other sections of society should be done through subsidies and not through market distorting differential indirect taxation.

Then there is the concern of the states of their revenue shrinking due to the loss of their independent fiduciary powers. This issue could have been addressed by making an assessment of the total revenue that is garnered by the centre and the states from taxing different goods and services as this data is there with them. Then through mathematical procedures a single tax rate could have been worked out for all goods and services that would yield the same total revenue as is being garnered currently and a formula worked out for sharing this revenue in the same proportion as it is being shared between the centre and all the states at present by iterating the formula over the tax revenue data over the past decade or so. There is anyway a provision for the compensation of states for any revenue loss under GST from the levels prevailing currently, primarily because of the fear of manufacturing states like Tamil Nadu, Maharashtra and Punjab that they will lose revenue since the GST is a consumption tax that will be levied at the point of sale. This compensation provision could take care of any anomalies in the revenue sharing results arising from the formula. Over time as the bouyancy of the taxes increases substantially due to almost hundred percent compliance under the new single tax regime, the sharing formula could be revised through consensus between the centre and the states.

Since there are now still a number of tax rates effectively amounting to more than ten in the new GST regime, there is also going to be in place a very complicated system of tax administration for this which is internet and computer based in a country which has very poor internet connectivity and low computer availability and literacy in most areas including in cities and towns. To make sure people do not evade taxes an input tax credit system is going to be implemented which will work as shown in the graphic below.

In the above graphic we ignore for the time being the tax that the manufacturer has paid on the goods and services procured by him and assume they are a part of his selling price of Rs 100. He adds Rs 5 for GST at 5 per cent and sells the product to the wholesaler for Rs 105 and uploads the invoice for the same to the Goods and Service Tax Network (GSTN), the internet based software that is to keep all the tax data, with which he is registered. Every month the manufacturer pays the total tax that he has collected from his sales in accordance with the invoices he has uploaded on to the GSTN to the tax authorities. The wholesaler on his part sells the product to the retailer at Rs 120 and adds Rs 6 for GST at 5 per cent. Since he has already paid Rs 5 of the tax to the manufacturer he can claim the tax credit from the invoice that has been uploaded onto GSTN by the manufacturer and will pay only the net GST to the tax authorities. The wholesaler too immediately uploads the invoice onto the GSTN. The retailer sells the product for Rs 160 and adds a tax of Rs 8 at 5 per cent when selling to the consumer, who, thus, pays the full tax. The retailer too pays only the net GST to the tax authorities after uploading the invoice of sale to the consumer onto the GSTN.

In theory the manufacturer, wholesaler and retailer will all demand that not only they get tax paid invoices from their vendors but that these are also uploaded onto the GSTN by those who sell to them because otherwise they will not be able to claim tax credits and will have to pay the whole GST themselves. However, this will be very difficult to implement on the ground for the following reasons.

1. Presently most of the business in this country is done without paying taxes and issuing tax paid invoices and so to expect that people will all of a sudden begin doing so from July 1^st 2017 is a bit of an exaggeration. Primarily because once tax paid invoices are issued and uploaded onto the GSTN, these will enhance the turnover and profits of the company and make them liable to paying greater direct taxes.

2. Given the huge number of rates, exemptions and surcharges, the format for invoices and the process of their uploading to GSTN is complicated as are the formats for the returns that have to be filed every month and so these businesses will have to invest in computers and become computer savvy to be able to issue tax paid invoices and also upload them onto the GSTN and file their returns. There is also the need for good internet connectivity. The uploading to GSTN has to be done through service providers who have been appointed for the same by the tax authorities. However, at the moment the number of such service providers is woefully low. In the absence of good data connectivity and adequate numbers of well equipped service providers, the uploading of invoices and filing of returns will be a problem. 

3. Given these problems, businesses with annual turnover of Rs 20 lakhs in most states and Rs 10 lakhs in the northeast have been given the choice to not be registered with the GSTN. Businesses with annual turnover of Rs 20 to 75 lakhs will not have to pay taxes in accordance with their sales but upload only bills of supply and not tax paid invoices onto the GSTN  and pay 1 per cent tax on their declared turnover. However, these exemptions will complicate matters further. Larger businesses of annual turnover greater than Rs 75 lakhs which have to upload their invoices will have to pay the whole tax on the sale of their products including the tax on inputs not paid by suppliers who are not registered on the GSTN and they will have to also upload the said tax details on GSTN so that their customers can claim the input tax. This means on the one hand that the big businesses have an added burden of preparing invoices for their input purchases from small businesses and uploading them onto the GSTN and on the other hand paying the tax, known as reverse charge, not paid by their vendors who are exempted from doing so. Moreover, since a lot of these small businesses have been evading taxes both indirect and direct, they can merrily continue to do so as they do not have to upload their sale invoices onto the GSTN. All this could easily have been avoided if there had been just one rate of tax for all goods and services and so even small businesses could have been registered on GSTN and made to upload invoices and pay taxes as the procedure would be very simple and could be done from mobile phones through messaging based apps that do not require internet connectivity that can be designed for the purpose. They would just have to enter the amount of the transaction and the tax without giving details of the nature of goods and services sold as all are to be taxed at the same rate.

4. Finally, a lot of over and under invoicing goes on presently to evade taxes and often goods are transported in amounts which do not physically tally with the invoices. To check this malpractice, eway bills have been introduced in the new GST regime. An eway bill corresponding to the invoice generated has to be prepared and uploaded for transport of goods between any two businesses whether physically proximate or not. These eway bills can be checked at any time during the transportation of the goods to verify whether they correspond to the actual goods being transported. Once again the preparation and uploading of these eway bills is going to prove a great challenge and given the fact that these eway bills have specified timelines within which they are valid, there is bound to be chaos in the transportation of goods. If there is a single rate of tax and all businesses big and small have to pay this tax and be registered on the GSTN, then the scope for tax evasion is almost nil and there is no need for a complicated eway bill system.
5. Apart from this, exporters have expressed concern about getting timely refunds of the GST paid on their inputs without which their working capital requirements will increase making their products less competitive on the international markets.

Thus, given the multiple tax rates, exemptions and surcharges, the unpreparedness of the GSTN and service providers to handle the huge amount of invoices and returns that are going to be uploaded, the reluctance of people to record their transactions and so increase their recorded incomes and the liability to pay direct taxes, the exemptions given to small businesses to not be part of the GSTN and the chaos that will rule in the transportation sector due to the eway bills, The GST rollout on July 1^st 2017 is bound to be vexing initially and will cause an even greater disruption than demonetisation did!!