India is set to introduce GST, Direct Taxes Code (DTC), Property Tax and organizational structures and governance of tax organizations, with a view to reducing compliance costs and uncertainties.
India’s International Linkages:
- GDP 2014 Current Exchange Rates USD 2.1 trillion
- GDP 2014 (PPP) USD 7.4 trillion
- Trade per capita (US $) 2012-2014 USD 822 Trade to GDP Ratio 2012-2014: 53.6
- Total Merchandise trade 2014 billion USD 784.6
- Exports 321.6 (1.69) Imports 463.0 (2.43)
- Total Services Trade 2014: USD 302.5 Billion
- Exports 155.6 (3.15) Imports 146.9 (3.07) (% of world total)
- Total Merchandise+ Services Trade 2014: USD 1087.1 Billion
- Trade Deficit USD 132.7 Billion
IMPACT OF GST
In India’s international trade in service transactions, Transportation services account for only 12 % of Total Exports, but 52.6 % of the Imports. It is in this sector therefore India will need to be a lot more competitive if it is to manage its large and persistent trade deficit. Recent initiatives of the Indian government on port development and inland transport development are therefore steps in the right direction.
In Merchandise Trade, a less well known indicator is moderately large trade surplus contributed by the agricultural sector. Thus 2014 agricultural products were 13.5 % of the exports, but 5.9 % of Imports. How to increase this surplus is a challenge for India. But it must be met to not just improve the trade balance, but to increase India’s strategic space globally. As agriculture sector is especially challenging in GST administration, how GST rules are structured for this sector will impact on meeting the above challenges. So these will need to be especially monitored.
- Combined Tax Revenue of Union and States : 2013-14
- Corporate Income Tax : INR 4.5 trillion ( 3.4 % )
- Individual Income Tax: INR 2.8 trillion. ( 2.2 % )
- Customs Duties : INR 2.0trillion ( 1.6% )
- Union Excise tax duties : INR 2.1 trillion ( 1.6 % )
- State Excises : INR 1.0 trillion ( 0.8 % )
- Total Excise: INR 3.1 Trillion ( 2.4 % )
- Service tax : INR 2.2 trillion ( 1.7 % )
- General Sales Tax: INR 5.6 trillion (4.4 %)
- General Sales Tax+ Service Tax + Excises=4.4+1.7+2.4=8.5%
In 2014-15, Sectoral composition of India’s Gross Value Added (GVA) was:
- Agriculture: 17.0%,
- Industry: 30.0%, (with Manufacturing Sub-sector share being 17.2 %)
- Services 53.0%.
India thus derives only 1.7 % of GDP in taxes from services contributing 53 percent of GDP (and even Services Tax was not levied till 1994), and 6.8 percent of GDP from manufacturing largely) contributing only 17.2 percent of GDP. As households spend greater of income on services as incomes increase, in the name of socialism, the Congress dominated governments which have been in power for most of the years since independence, have set up regressive tax system, disproportionately burdening lower half of the Indian households. GST will correct this imbalance.
In OECD: VAT/GST tax revenue averages: 6.2% (in 2012), lower than what India already collects from sales and excise taxes.
- The focus currently is on GST and on reforming tax administration.
- DTC and Property Tax will be more thoroughly reformed at a later stage.
- As intention of GST is to have economic burden borne by the final consumers, it is the consumptions taxes that need to be analysed.
Consumption taxes usually include:
- Value Added Taxes (VAT and its equivalent in several jurisdictions the Goods and Services Tax – GST)
- Manufacturing import level sales taxes on goods;
- Retail sales taxes on goods
- Excise taxes which are on production of goods and not on sales.
- Taxes on services (if levied separately from taxes on goods)
- Customs duties
The taxes can be:
- Ad-valorem, i.e. as percent of price
- Specific: in nominal terms per unit.
- Or a combination of the two.
VAT/GST can be based on:
- Origin : Where production occurs
- Destination: where consumption occurs
The destination basis is preferred when the objective is to tax consumption.
The benefits of VAT/GST include:
- Potentially Low Rate-Broad Base
- Additional (to income tax) broad-base Revenue Source –Any modern economy needs both.
- Easier to Exempt Exports
- Potential to improve accounting standards
- Can potentially Cope with Ageing Population But Transition Issues
India’s Constitution does not permit the Union Government to levy Sales Taxes on Goods, and the State governments to levy sales taxes on Services. A Constitutional Amendment Bill 2014 (122nd Amendment) will correct this anomaly, once it is passed.
POTENTIAL ISSUES FOR GST RELEVANT TO INDIA
1. Zero Rating vs. Exemption
- No output tax but receives credit for input taxes; does not have to pay but does not receive credit for input taxes
2. Base Structure
- Narrow or Wide?
- Treatment of Small Firms
- Should Both Goods and Services be Included?
- Treatment of state enterprises
3. Defining place of supply particularly for services like Uber, Ola. Other digital services, professional services, etc.
4. Transition issues
- No international experience with dual rate (one at the Union, and one at the State level) for a federal country of this size.
- Transition costs could be large and prolonged, and flexibility required.
5. Rate Structure
- Single or Multiple Rates which may be Determined by relative elasticities.
6. Number of Taxpayers
- Manufactures (M), Wholesalers (W), and Retailers (R) - M+ W+ R will mean large number of tax payers.
- Capacity, Competence, and Resources of the Tax Administration
7. Treatment of Agriculture, Real Estate, and Finance Sectors
8. Treatment of cross border transactions. In Federal countries, such as India, inter-state transactions are possible
9. VAT/GST may not be Self-Enforcing, but is any tax?
GST AND AGRICULTURE
Agriculture is sensitive issue in India as over half of the population derives major part of livelihood from this sector, but it contributes less than one-fifth of India’s GVA.
In emerging economies, agricultural producers are outside the formal sector or do not have sufficient records for an accurate measurement of turnover.
Physical remoteness, seasonal nature (resulting in a mismatch of timing in inputs and outputs) complicate measurement & payment procedures. These result in higher administrative costs.
The sector is often a particular concern in the pursuit of wider distributional objectives. A tax on food is either borne by consumers through higher prices, or by farmers through reduced real income, or a combination of both.
Both of these options are perceived to be regressive (essentially for basic unprocessed vegetables). There is however debate in the literature as many farmers have high incomes.
Moreover, expenditure policies may be more efficient at achieving re-distributive priorities.
This suggests that agricultural products should be fully within the VAT system
Either taxed at regular rates or low rates (possibly zero)
Long-term objective in the treatment of agriculture is clear: tax agriculture as any other good, subject to the
But high collection costs may validate other methods
Exemption ensures that agriculture is taxed at a reduced but positive rate because of the absence of relief paid on inputs results in distortion in the production and a greater reliance on untaxed inputs.
VAT RATES IN OECD COUNTRIES
There is a wide range of lower rates, exemptions and special arrangements under VAT that are frequently designed for non-tax policy objectives. Uniform single rate for both the goods and the services is usually an ideal for tax neutrality, and for ease of administration and compliance. But it is not always achieved, particularly once the rate approaches 15 percent.
VAT preferential treatments are widely used in OECD countries, for equity or social objectives (basic essentials, health, education, etc.) or for practical (e.g. financial services) or historical reasons (postal services, letting of immovable property, etc.).
Broadening the tax base and eliminating reduced rates may help achieve the full potential of VAT.
In 2014, the VAT in Canada was as low as 5% (though in Canada, provinces levy separate VAT), while in Hungary it was 27%.
The OECD un-weighted average rate for 2012 was 18.7%
CONSIDERATIONS IN SETTING VAT THRESHOLD
- Empirical evidence suggests that a relatively small proportion of firms account for large proportion of potential VAT revenue.
- More effective to concentrate resources on the largest tax payers, as the revenue to be raised from smaller firms is seen insufficient to warrant the resources required for its collection.
- Despite significant variation, a useful rule of thumb is that the largest 10 percent of all firms account for 90 percent or more of all turnover.
- At the margin, a 1% increase in the threshold is initially very cheap in terms of revenue foregone, but becomes much more expensive at higher levels of turnover.
- If it were not for the costs of administering VAT (incurred by authorities) and complying with it (by tax payers), the best threshold would be zero. This would minimize distortions as well as maximize revenue.
- It is important to recognize that administrative costs are not exogenous: the costs of coping with each taxpayers depend on design choices as the frequency of audit, the nature of audit, the complexity of the tax structure, and so on.
- Experience indicates that setting too low a threshold can significantly compromise the political and
- administrative feasibility of a VAT.
- Some countries have different thresholds by sector, but limited economic rationale for this.
Part -2 will discuss measuring VAT performance to assess potential for progress, issues in taxing certain sectors, and recent developments in preparing for GST in India.