Reuters | Wed Jul 21, 2010 | 9:34pm IST
The central and state governments moved closer to ushering in a nationwide goods and services tax on April 1, 2011, a reform intended to cut business costs and boost government revenue. The reform would eliminate multiple indirect taxes levied by states and the central government, leading to a reduction in the average tax burden on companies and a rise in the country’s tax-to-GDP ratio. On Wednesday, federal and state finance ministers emerged from a meeting saying they had narrowed differences that have delayed implementation. States are fretting over loss of revenue and are negotiating how they will be compensated.
HOW WILL THE GST WORK?
The GST is an indirect tax that would replace existing levies such as excise duty, service tax, and value-added tax (VAT). Both the states and the central government would impose the tax on almost all goods and services produced in India or imported. Exports would not be subject to GST. For the first two years of operation, the proposal is for two rates both at the federal and state levels, converging to a single rate in the third year. Producers would receive credits for tax paid earlier, which would eliminate multiple taxations on the same product or service. Direct taxes, such as income tax, corporate tax and capital gains tax would not be affected.
WHAT’S THE RATIONALE FOR THE GST?
Eliminating a multiplicity of existing indirect taxes would simplify the tax structure, broaden the tax base, and create a common market across states and centrally administered districts. Increased compliance and fewer exemptions to GST would lift India’s federal tax-to-GDP ratio from the 11.8 percent it currently estimates for the financial year 2012/13. At the same time GST would lower the average tax burden for companies that now pay "cascading" taxes on top of taxes through the production process. By lowering business costs it would boost economic growth and increase exports, proponents argue, and bring India in line with practices in many developed economies. Reducing production costs would make exporters more competitive. "The GST may usher in the possibility of a collective gain for industry, trade, agriculture and common consumers as well as for the central government and the state governments," a November report by a government panel said.
WHAT ARE THE PROPOSED GST RATES?
For the first year: 10 percent and 6 percent. Depending on revenue collections and compensation handouts to states, the higher rate would come down to 9 percent in the second year, and the two rates would converge at 8 percent in the third year. The highest rate of taxation under the new system would be around 15 percent in the first year, and eventually come down to 12 percent. By comparison, the current rate of the various indirect taxes levied in India amounts to roughly 20 percent, and can be much higher.
ARE THERE EXEMPTIONS PROPOSED?
Yes. Goods deemed necessary or of basic importance would be taxed at a lower rate. The government will review the various lists of exempted goods to align them at the federal and state levels. Asim Dasgupta, the chairman of the panel of state finance ministers, said alcohol, petroleum and electricity would not come under GST.
WILL THE STATES LOSE OUT?
New Delhi will compensate states for potential lost revenue and Finance Minister Pranab Mukherjee has assured states that if needed, he would sweeten a 500-billion-rupee ($10.6 billion) fund that a government panel has proposed as an incentive for the states to buy into GST.
WHAT HAPPENS NEXT?
The legislation to make constitutional amendments needs to be finalised and the mechanism for administering the tax needs to be created. Officials have said they hope the legislation will be introduced in parliament in the session that begins on July 26. The government also needs to set up the technology infrastructure to manage the tax.
WHAT IS THE REVENUE IMPACT?
The GST is initially intended to be revenue-neutral but is eventually expected to increase the tax uptake thanks to more efficient collection and increased compliance.
WHAT ABOUT THE ECONOMIC IMPACT?
Implementation of a comprehensive GST would lift India’s economy of over $1 trillion by between 0.9 percent and 1.7 percent, on top of whatever growth would otherwise be achieved, according to a report by the New Delhi-based economic think tank the National Council of Applied Economic Research. Exports would rise by between 3.2 percent and 6.3 percent, while imports would increase 2.4 percent to 4.7 percent, the study found.