Replacing CST by GST in some states would affect the trade as well as revenue of those statesThe Union Budget speech 2013 by P Chidambaram reiterated the commitment of the Union government towards the implementation of the goods and services tax (GST). Referring to the progress in this direction, the finance minister stated that a broad consensus has been achieved between the Union government and the “overwhelming majority of the states” for the introduction of GST.This is a very important move towards the introduction of GST. In fact, for quite some time, there have been bumps and road-blocks for the implementation of GST. There have been some disagreements between the Centre and the states on compensation for the central sales tax (CST) and on the issue related to autonomy of the states.

The statement of Chidambaram was very significant. It followed the amicable conclusion of the Bhubaneswar meeting of the empowered committee (EC) wherein he has announced the intention of the central government to fully compensate the states for phasing out CST by giving them R34,000 crore. The finance minister stated that the states would be given 100%, 75% and 50% of the compensation for the years 2010-11, 2011-12 and 2012-13, respectively. The finance minister has set in motion the process of sorting out one of the most contentious issues by providing for R9,000 crore as the first instalment of the compensation in the Union Budget 2013.

To resolve the other issues related to the structure of GST and the issues incorporated in the Constitutional Amendment Bill, in November 2012 the EC announced the formation of a sub-group. To iron out the differences on some major issues, three sub-committees were formed to deal with the issues relating to a revenue-neutral rate, dual control of traders, and the complications arising from an integrated GST. The report of the sub-group on the design of GST was discussed in the Bhubaneswar meeting of the EC in the last week of January wherein some issues of conflict between the Centre and the states were resolved with a broad consensus on the GST design proposed by the sub-committee.

While the decision on the design of GST will be taken up further in the May meeting of the EC, it is proposed that some consensus be arrived at on the design of GST by taking into account the autonomy of the states. The broad contours of the design are as follows:

First, while in the original design it was proposed that there would be one standard rate, and two other rates (one low and another high rate) on necessities and on demerit goods, respectively, the new design proposes to have a band of rates. Based on the European Model, it proposes to have a floor rate and a ceiling rate within which the states would be free to have a high or a low rate. Taking into account the autonomy aspects, the states would be allowed to increase their GST rate (whenever they need to mobilise more resources) within the band rate. This would mean that there would be no uniformity in the rates of GST all over the country. The rates would vary from state to state, as has been the case under the sales tax regime.

Second, the states would be free to adopt GST simultaneously, in one go, or could introduce it whenever they want to, at a later date, as has been the case under VAT. The issue of introduction of GST would be optional for the states.

Third, the dispute resolution mechanism proposed in the Constitutional Amendment Bill won’t be implemented.

Given the above design of GST, India would have a new Indian avatar of GST, devoid of the major economic merits of a single Union with a uniform rate structure. It is, therefore, important that the forthcoming meeting of EC on May 10-11 takes note of some of the important consequences of this policy.

First, unlike the introduction of VAT when some states introduced it and others refrained from doing so, under the GST regime, the issue of Integrated GST (IGST) would create further complications. Since the existing CST is an origin-based tax yielding larger revenue to the producing states, its continuation in some states and replacing it by IGST in others would affect the trade as well as revenue of the states. With regard to trade, the introduction of IGST would reduce cascading and, hence, the overall transaction cost. This would give incentive to the business to move to the states that introduce GST. This would create distortion in the existing business structure. Hence, the next meeting of the EC must consider this issue and ensure that the CST is replaced by IGST whether a state is adopting GST or not. Since the Centre is compensating the states for this, there should be no problem to the states to have a consensus on this issue.

Second, the idea of having a band rate is welcome but the policy needs a re-look. Under the present scenario, the band rates would prevail for all the commodities subject to different rates of tax. This would completely distort the rate structure of the states. It would be difficult for any one to easily understand the working of the overall tax system. There would be a large number of tax rates and the states would also not benefit much from their ‘save their autonomy’ attitude. It is, therefore, proposed that the EC takes a re-look at the rate structure. We propose that the band rate be fixed for only demerit or polluting goods and a standard rate for the rest of the goods. This would keep the overall tax structure uniform and have variation in rates for only a few select goods not more than a dozen in number.

The Constitutional Amendment Bill must include all the commodities under GST (i.e. petroleum products etc should not be left out of the purview of GST). The GST rate on all the items should be the same for all the states.

As a next step, demerit goods must be listed for the states so that they can select those items that need to have a different rate in their state. This is important because all the states might not require additional non-rebatable tax on all the demerit goods because those goods may not be produced in their state, for example coal. The EC might convince the states that this will help them to mobilise more revenue resources and safeguard their autonomy.

The states will be free to have an additional tax (could be termed as pollution tax) on a few select demerit or polluting goods. This would enable them to get more revenue and also give them the fiscal space they want.

Finally, in the context of the Constitutional Amendment Bill, the consensus has been arrived at to do away with the new GST Dispute Settlement Authority. However, it would be more in tune with the spirit of cooperative federalism if the proposed GST council is also constituted on the pattern of the present EC which has had an excellent track record of reforming the tax system over the last decade. Accordingly, the proposed membership of the council should comprise the Union finance minister and all the finance ministers of states and the Union Territories as its members. However, unlike the present EC, which is a “society” registered under the Societies Registration Act, it should be a Constitutional Body and have a defined regulatory authority with strict punitive powers.

The author is former member secretary of the Empowered Committee of State Finance Ministers for the Introduction of VAT, and currently director, Foundation for Public Economics and Policy Research, New Delhi