Let us start with demonetisation. What is the most important lesson that we have learnt from this exercise? It is that those in the habit of accumulating black money will try and game the system rather than let go of their illegal hordes. This is what happened. Huge amounts of black money were deposited regardless of the warnings from the Government that they would be tracked and indicted later for depositing the demonetised notes in excess of the limits prescribed. So almost all the money was deposited and now the Income Tax Department is saddled with the Herculean task of sending notices to these 18 lakh depositors of unaccounted money and proceeding against them. Most have not responded to the email notices that have been sent to them and not filed income tax returns that account for the deposits they have made. Due to the lack of staff, the Income Tax Department scrutinises in detail the returns of only a few thousand assessees every year and so it can easily be imagined how difficult it will be for it to scrutinise these 18 lakh depositors. Since email notices have not garnered much response, now written notices have to be sent and then staff have to be deployed to scrutinise the books of all these people. There has been an increase in the number of income tax assessees and the income tax deposited but this has been of the same order of increase as in earlier years and so it can safely be assumed that unearthing the black money deposited is going to be a long haul. All this at a huge cost to the economy in general and to poor people in particular.
Given this tendency of the black people of this country, who are incidentally also the top 1% economically, to game the system, one would have thought that the Government would have designed a GST that would have prevented such gaming. But no, once again there was great fanfare, as with the announcement of demonetisation and a worthless and unworkable GST was launched. Modi in his eagerness to copy Nehru's freedom at midnight speech, delivered another one at a specially called midnight session of parliament, declaring that he was freeing the economy of the country from the tyranny of multiple indirect taxes!!! But what actually happened is another sordid story altogether.
The lynch pin of the GST is the input tax credit system. I had described this in my first post on GST before it was launched, in which I had predicted that the faulty way in which the GST had been designed, it was bound to fail and I will repeat it here as without understanding this, one cannot appreciate the monumental blunder that has been committed!!
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 and the taxes paid in time by those who sell to them because otherwise they will not be able to claim input tax credits and will have to pay the whole GST themselves. At the same time the Government benefits because the input tax credit chain ensures that each and every transaction is tracked and taxes paid on it. Not only does this broaden the indirect tax base but also by completely tracking the income and expenditure of business entities, gives the Government a correct picture of the net incomes earned by them and so increases the direct tax base considerably as incomes cannot be concealed to evade tax while at the same time by making the tax payment system more or less automatic, the indirect tax bureaucracy can be freed to monitor the direct tax system which will now be augmented due to better indirect tax reporting. More importantly by unifying the separate Central and State indirect tax systems and simplifying them, the flow of economic activities would be smoothened bringing down the overall taxation and complexities of the economic system.
However, for the input tax credit system to work smoothly it is essential that there be only one or at the most two tax rates. This is because of the fact that with multiple tax rates, there is a need to classify goods and services which are to be taxed differently and this leads to complexities in the filing of computerised returns which in turn mean that small businesses below a certain threshold of turnover have to be exempted from registering in the GSTN altogether because they will not be able to comply with the complicated procedures and a considerable number of others below a slightly higher threshold will have to be exempted from filing the returns known as GSTRs and instead will have to pay a composition tax on their total turnover. Originally as conceived there were three returns to be filed every month. GSTR1 for the previous month was to be filed first by the 10th of the following month giving the details of all the invoices of purchase and sale of various items and the taxes paid or collected on them. Once this was done then all assessees could compare their returns with those of their suppliers and buyers to see whether all the returns matched and file GSTR2 by the 20th of the month, indicating those items of return that were not matching and also getting in touch with the suppliers and customers to rectify the anomalies. Finally once all the returns were matched and the input tax credits availed, then the final return along with the tax to be paid was to be filed by the last day of the month. There was a penalty of Rs 200 per day to be paid if the returns were not filed and taxes not paid by the stipulated date.
Unfortunately, things went awry from the first month after launch itself!! The main reason was that the complicated Harmonised System of Nomenclature (HSN) used in the excise duty regime earlier was retained in the GST regime. HSN was introduced by the World Customs Organisation to have a standard format of classification for goods which are traded internationally and have different tariffs so that international trade is smooth. This was adopted by the Central Board of Customs and Excise in India both for the customs duties and the excise duties so as to harmonise both duties across different goods. However, in the new GST system, which by design has a much lesser number of taxes by categories rather than goods, this was not necessary as even if there were effectively ten different tax slabs with exemptions and cesses, instead of detailed classification of each type of good only the broad categories of taxation in which the goods fell could have been named. Similarly for services too, the Services Account Code with detailed classification of services was retained even though there were just two rates of GST for services. What this did was it complicated hugely the returns filing process as each invoice had to mention the correct HSN or SAC number of the good or service sold and the tax that had been collected on it by the vendor divided into State GST, Central GST and Interstate GST. If there was a mistake then the return would not be accepted by the GSTN and if there was an anomaly in filing between actual sale and the return, then the GSTR1 of one business would not tally with that filed by another business with which it had transacted. Moreover, since the GST was introduced hastily without proper beta testing of the GSTN software, the system had innumerable glitches and often crashed. Also due to even further complications, the electronic waybill system which was to replace the earlier system of paper transport challans which used to be carried by the transporting vehicles was not ready due to the unpreparedness of the GSTN software. So while the earlier transport challans and border checking of transport vehicles was removed, the e-way bills and their checking through handheld devices were not operational.
Therefore, in the first month itself the three stage filing system had to be put in abeyance and in great hurry an ad hoc system of filing of a hastily devised GSTR3b was introduced in which businesses only had to file self assessed returns of the overall buying and selling they had done and not the detailed invoices with their goods and services, HSN and SAC codes, amounts and taxes and pay the net tax as calculated by the businesses on the basis of this self assessment. This ad hoc measure was necessary as otherwise taxes would not be paid since the originally designed return filing system had failed and this would greatly jeopardise the finances of the central and state governments.
The provision to exempt businesses with turnover less than Rs 20 lakhs (Rs 10 lakhs in the North East) from registering in GSTN and to exempt businesses with a turnover less than Rs 1.5 crore (Rs 75 lakhs in the North East and Himachal Pradesh) from filing the GSTRs and instead avail of the composition scheme, provided loopholes for businesses to evade taxes and these were necessitated precisely because of the bad design of the GST. Even though the introduction of the reverse charge mechanism, which required businesses registered in GST to pay the GST on behalf of their vendors who were not registered on GST, theoretically created a pressure system that would bring in smaller businesses into the tax net as they would find their business going to bigger businesses, in effect because of the badly designed GST this did not happen as the input tax chain did not take off in the first place.
Consequently, for the first month of July 2017 as much as Rs 92,283 crores was collected as GST, which was more than the Government's estimate that it should be 91,000 crores as calculated from the budgets of the Central and State Governments. However, since Government budget estimates are always suspect, a better way to analyse the collection is to break it down into its components. The CGST collection was Rs 14,894 crores, SGST was Rs 22,722 crores and IGST was Rs 47,469 crores. This does not constitute a rise of 22 per cent in indirect tax collection over that of July 2016 as was achieved in the earlier year. Anyway, the crooked businessmen soon cottoned on to the fact that without GSTR1, GSTR2 and GSTR3 being filed, the input chain would not work and so there was no way in which the exact transactions could be tracked. Even though there were declarations from time to time that GSTR1 would have to be filed in delayed timelines and eventually when the system became operational then all the ad hoc GSTR3bs would be tallied retrospectively with the actual GSTRs 1,2 and 3 that would be filed later, crooked businessmen began to game the system and file false GSTR3b returns less than their actual turnover. So for August 2017 the GST collections dipped to Rs 90,669 crores and after rising slightly in September 2017 to Rs 92,150 crores fell drastically for October 2017 to Rs 83,346 crores as the floodgates of evasion opened as there was no border checking of transportation and no e-waybill monitoring and so crooked businessmen began under reporting their turnover. The GST collection fell further to Rs 80,808 crores in November 2017.
This precipitate fall in GST collection was also due to a parallel reduction in taxes on various goods and services as protests against the high and often irrational and conflicting taxes gained ground. Especially so in the run up to the Gujarat assembly elections when the Government had to backtrack not only on tax rates but also on the filing of GSTR1 which was put in abeyance for the current financial year, thus completely freeing businesses from truly reporting their turnover. The Government then frantically began taking punitive measures as predictions were that there would be a considerable shortfall in tax collection if things went on like this and it increased the heat on businesses and so the GST collection for December 2017 has shown a slight increase to Rs 86,703 crores but is still highly deficient.
So the original aim of the GST is nowhere near being achieved. Since the filing of GSTR 1,2 and 3 is in abeyance and there is no border checking of transport whatsoever, massive evasion of taxes is going on. Businesses are selling without invoices and without charging taxes and so both evading GST and also by under reporting their income, evading income tax. The building shown below is the wholesale pharmaceutical market in Indore. It has been a den of corruption for long with the selling of spurious drugs and non-tax paid drugs. The building itself has been built by violating the municipal building rules in a big way.
The Governments at the Centre and the States are obviously very concerned because their revenues are falling. So there are constant meetings going on to try and salvage something from this Quixotic fiasco that has severely dented Government revenue and threatens to get worse with time. But as is the ham handed norm with all government efforts, the means being suggested are going to be ineffective. What is coming out in odd statements here and there from the Government is that the returns filing system will be made simpler with the filing of just one return but the input tax chain will still be retained. Now how the input tax chain can be retained with filing just one return without first matching invoices in the preliminary returns is not being explained. Actually the only solution for salvaging the GST is to drastically cut down the number of taxes to just one or at the most two slabs and do away with the HSN and SAC altogether. Indeed if there is no HSN and SAC and the tax rates are just one or two, then invoice reporting will become very easy and can be done through a much simpler software on ordinary mobile phones in real time obviating the problem of invoices not matching greatly. So no one needs to be exempted whatsoever as even a very small business person will just have to press a few buttons on her feature phone to upload the details of the business done by her onto the GSTN. This simple system would also alleviate the woes being faced by craftsmen and small enterprises in the current system as they have suffered due to their inability to comply with the complicated return filing process. But even though there have been recent announcements that the number of tax slabs and the rates of tax will be reduced, there has been no statement that the HSN and the SAC, which are the main culprits, will be scrapped. Possibly its only a show being put on by the Government that it wants to curb tax evasion and black money generation and it is not really interested in doing so. Otherwise it is difficult to explain this continued refusal to put a simple GST system in place that can both curb tax evasion and substantially increase both indirect and direct tax collection while bringing down the overall tax rates and complexity of doing business.
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. Similarly, instead of having higher taxes for luxury goods, it is better to tax the high incomes of those who buy such goods. A single rate of tax ensures that there is no market distortion and the economy functions smoothly.
What is galling is that despite the GST design and implementation completely violating the above well established principle of indirect taxation and so being a colossal failure, there is not enough criticism of it. Most independent experts are saying that there are teething problems which will be overcome with time as the system stabilises and not that there is need for a drastic redesign of the GST. Why in the first place is there a need for such revision and modification when, beginning with France in 1954, there are 160 other countries that have implemented GST before India and so there is already a wealth of evidence about what works and what doesn't that we can draw upon instead of inventing the wheel again like crooked fools.
The only person within the Government who has spoken some sense throughout is Arvind Subramanian, the Chief Economic Advisor to the Government of India. From the beginning he has been saying that there should be a single revenue neutral GST tax rate of around 15-16% and he has repeated this in the recently released Annual Economic Survey. The problem with this is that he has calculated this rate on the basis of historical tax collection by the Centre and the States in a regime of massive tax evasion earlier. Also with such a high rate of taxation, many of the wage goods, which are used by the majority of the population, will have to be exempted from taxation, leading to crooked businessmen exploiting this loophole. However, if there is a low single tax rate of about 6%, then evasion will be almost completely curbed due to a foolproof input tax chain and so even on this low tax rate, overall there will be revenue neutrality or even excess of revenue may be earned on a much larger tax base. Moreover, if indirect tax evasion is curbed then the reported business incomes will increase substantially resulting in higher direct tax collections leading to greater tax buoyancy. One would have expected Subramanian to also criticise in the Economic Survey, the retention of the HSN and SAC which are the main culprits but being essentially an outsider in the cesspool that is the Ministry of Finance, he has not been able to do this. There is going to be a reduction in indirect tax collection this year due to the GST fiasco which has also severely affected small businesses and the overall employment scenario and there is no way in which the present GST can stabilise and the economy become free without a scrapping of the HSN and SAC and a drastic redesign. Yet he says the overall economic outlook is good.
Modi meanwhile in the same interview in which he has admitted to the failure of demonetisation and GST, has brushed this aside lightly, despite the grave negative effects on the economy and stated that people are selling Pakodas for a living and that should be counted as employment created by his Government!! The problem with this kind of outrageous statement is that like in the case of his tea selling earlier, pakoda selling from small road side stalls too, is in no way facilitated by the policies of the Government but are the result of its anti-people policies which lead to the informalisation of the economy and forced subsistence living by the majority, so that more and more wealth gets concentrated in the hands of a miniscule few. If pakoda selling or tea selling, for that matter, are such great professions then the question arises as to why Modi gave them up to become the Prime Minister!!!