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Rebooting Economy XXIV: 7 critical GST flaws govt needs to address at the earliest

Gross mismanagement of the economy, starting with demonetisation in November 2016 and continued with untimely, unplanned and sudden nation-wide lockdown has compounded the GST problem. Centre's refusal to pay compensation to states now may derail it completely

Rebooting Economy XXIV: 7 critical GST flaws govt needs to address at the earliest

It is no secret that the GST's design was seriously flawed and its implementation was equally so

Going by the Centre's refusal to honour its commitment on the Goods and Services Tax (GST) to compensate states for giving up their constitutional rights to levy tax and the consequent loss of their source of revenue, there is a real danger of it being derailed and end "cooperative federalism" with it.

It is no secret that the GST's design was seriously flawed and its implementation was equally so. But these problems went unaddressed for three years. Signs of trouble were visible on July 1, 2017, the day the Centre rolled it out while also deferring its implementation by two months. That reflected continuation of an unthinking and unplanned approach to the economy that was so evident in the demonetisation move a few months earlier.  

The untimely, unplanned and sudden lockdown of the economy when the COVID-19 cases were about 650 on March 24 and then continued unlocking when it had grown exponentially to more than 3.6 million in number with daily cases touching 80,000 now have delivered a deadly blow to the GST.

Here are some of the critical structural and operational flaws in the GST that have been ignored for more than three years.

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Bringing in half-baked GST as a major reform initiative

The GST was showcased as "one tax one nation" at a midnight session of Parliament on June 30-July 1, 2017. It was billed as "second freedom fight" which would get rid of black money, epitomise "cooperative federalism", bring efficiency to the tax system through a transparent and simple mechanism by merging eight Central and nine state indirect taxes.  

A few years ago, in 2019, the chairman of the 13th Finance Commission and a well-known tax expert Vijay Kelkar had publicly claimed that a well-designed GST would increase GDP growth by 2-2.5% and export by 10-14. This came handy while selling GST and was repeated by the government.

None of it would, however, materialise. Its poor design and introduction without preparations delivered the second big blow to the economy already reeling under the demonetisation shock of November 2016 to derail India's growth story much before the COVID-19 pandemic hit.

One such big structural flaw in its design, which continues till today, is its nine tax rates - 0%, 0.25%, 3%, 5%, 12%, 18%, 28%, composite tax of 1% (for below Rs 1.5 crore turnover) and a cess over and above 28% on sin and luxury goods that goes to the Centre's kitty and is meant for compensating states for their revenue loss - while leaving out several high-value items from its ambit.  

The zero tax is important because 149 items were listed under it, unlike any other country in the world, and needed to be factored in while determining the tax liability of a firm.

This multiplicity of taxes ignored both the global experience and advice of the government appointed expert committee under the then Chief Economic Adviser (CEA) Aravind Subramanian.

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The committee's report, "Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)", submitted on December 4, 2015, said: "Ideally, the GST should aspire to a single rate, which would then also be the standard rate. Since 2000, about 90 per cent of countries that have adopted a VAT have chosen to have a single rate."  

It recommended three tax rates: 12% (Centre plus states) covering most items with two standard rates varying between 17-18%. When the UPA regime was deliberating on it during the previous decade, a tentative single rate of 18% had been fixed.  

The GST left out several high-value items like petroleum products, alcohol for human consumption, real estate and electricity, thereby having four additional indirect taxes: Customs, Excise Duty, Service Tax and Stamp Duty. This continues even today.  

That is not all. GST tax slabs defy logic and reflect the overwhelming influence of vested interests.

Luxury items like rough diamonds, precious and semi-precious stones attract 0.25% GST and polished diamonds, gold, platinum and silver ornaments attract 3%, while humble tendu leaves used for bidi making by the rural poor, 'katha', a wood extract used in 'paan' and biscuits given to poor children in Anganwadi centres attract 18% GST.

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The second big design flaw is its highly complex implementation mechanism which imposes a very high cost on firms.

For example, a pan-Indian firm (a cycle/motorcycle maker or a potato chips/cold drink maker) needs to file 988 GST returns every single year.  

This is because it needs to file two returns: GSTR-1 (outward supply of goods and services) and GSTR-3B (summarised details with input tax claims), every month (24 a year), and two annual returns, GSTR-9 (annual return) and GSTR-9C (GST audit). These are to be filed with state governments as well as the central government.

Since there are 28 states and 9 union territories (after J&K's downgrading), the total number of returns to be filed is 962 (24 multiplied by 37 plus 2 multiplied by 37). Plus, a firm needs to file 24 GSTR-1 and GSTR-3B in a year, and one GSTR-9 and one GSTR-9C as well to the central government (26 returns).  

The actual documentation work is far more daunting and costly. A GST expert says to file these GST returns a firm would have to track all its warehouses and office establishments in every single state every single month.

Think of the enormity of paperwork, deployment of manpower and establishment costs that the GST imposes on more than 10 million companies registered with it. Plus, officials needed to police the system.  

More than three years after the GST was introduced, the Centre is still struggling with the return formats and the IT system handling it to manage it properly with no end in sight.

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The third flaw is the design of "input credit" system. What it means is that while a firm pays tax on output, it claims refund of the tax paid on inputs. This hit the unorganised sector hard, derailing their businesses.

An authority on taxation, Prof. Arun Kumar of the Institute of Social Sciences (ISS), explains how: small firms with an annual turnover of less than Rs 40 lakh (earlier Rs 20 lakh) are exempt from GST and need not be registered, which means bigger firms buying from them can't claim input credit. Thus, they opt for bigger and registered firms for inputs, damaging small and unorganised businesses.

The fourth flaw is it did not envisage proper training for businesses or officials before rolling out such a complex tax system, even when it had the example of Malaysia before it, which adopted such a system in 2015 after elaborate planning and months of preparation and yet went through a prolonged turmoil.

Immediately after bringing in the GST, the Centre had to give two additional months for businesses to comply.

The GST Network (GSTN), the IT backbone of the GST, is not ready even more than three years later. There was no dry run in 2017. Technical glitches continue; officials continued their training in 2018 and 2019. In July 2019, the Centre decided to remove private players from GSTN and turn it into a fully government-owned entity, reflecting the failure of private partners brought in to run it.

The failure of GSTN meant matching of details filed could not be done automatically, leading to refund of input credit claims without verification, which continues till now.

The Subramanian committee had forewarned about the dangers of not designing the GST right, particularly about keeping its administration simple. After resigning as the CEA, Subramanian described demonetisation and GST as the "twin shocks" that derailed the Indian economy a year and a half before the pandemic struck.

A World Bank paper of 2018 found the GST more complex (with high and multiple tax rates) than the comparable systems in 115 countries, which, it said, added to the cost of compliance and incentivised tax evasion. It called for "appropriately structured and resourced administration, compliance strategies based on a balanced mix of education and assistance programs and risk-based audit programs".

The Centre did not pay heed.

Flaws that operationalisation of GST brought to fore

The impact of design flaws got reflected in the implementation of GST but went unaddressed too.  

It is not even fully operational more three years later. Here is how.

First, GST refunds are being given without verification of input credit claims.

The Comptroller and Auditor General of India (CAG) in its 2019 report pointed out why so. It said though filing GSTR-1 - which provides details of outward supplies/vouchers - was mandatory, not many were filing it and the subsequent introduction of summary self-assessed returns, GSTR-3B, further disincentivised not filing the GSTR-1.

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The GSTR-3B was a temporary arrangement until GSTR-3 (summary of outward supplies, input credit claims) was to be introduced. There is no sign of it yet. Besides, not many are filing GSTR-3B either. In a reply to the Rajya Sabha in July 2019, the government said only 75.3 lakh filed the return out of 1.02 registered firms in May 2019, a shortfall of 27%.

Does this 27% shortfall mean those firms are evading GST? Nobody knows.

GSTR-2 was also to be filed for inward purchases/invoices; GSTR-3 was to be generated by matching GSTR-1 and 2. The enforcement of GSTR-2 remains postponed.

Second, the filing of GSTR-9C - which provides GST tax audit details - has not been enforced yet. Every year the deadline is extended, the last one advancing it to April 2021. As a result, the GST liabilities, validity of refund claims etc. of the firms go unaudited.

As a result of all this mess, nobody knows what is happening with GST.

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This mess has led to the proliferation of an industry of fake claims. The Centre told the Rajya Sabha last year that fake claims of Rs 11,518.6 crore were detected between July 2017- May 2019.

Expectedly, the Centre has little idea about GST collection. The gap between its estimates/revised estimates and actual collection has grown exponentially - as mapped below. The FY20 data is up to December 2019 and provisional, as it told the Rajya Sabha.

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Not just that, the Centre has no idea about its GST collection since March 2020. Its book-keeper, the Controller General of Accounts (CGA), has not updated its accounts since February 2020.

Third, the GST council keeps revising tax rates and issues guidelines so frequently that even GST professionals complain of not being able to keep up with it, reflecting a perpetual state of confusion in the GST regime.

How would such a tax system eliminate black money, bring efficiency in tax collection and boost export and GDP growth is anybody's guess.

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Can GST be made simpler and efficient?

Yes, says Prof. Arun Kumar.

He identifies the input credit system as the main culprit and suggests that it should be removed. He says since the final burden is on consumers, the GST should be turned into "last-point" tax, like earlier sales tax, for example. This will eliminate the enormous burden of filing and tracking who paid what to whom to claim input credit tax at every intermediary stage and then get refunded without, in any way, reducing tax collection.

He argues that this would also help the unorganised sector also because without input credit tax they would be back in the game. The gain to the unorganised sector would far outweigh the loss to organised sector that this change may bring.  

He also argues that since 5% of firms pay 95% of taxes, as former Finance Minister Arun Jaitley used to claim, it wouldn't matter much if some firms don't pay GST. By focusing on simplifying the system and making it more efficient would pay a better dividend.  

Threat to GST and cooperative federalism

While Finance Minister Nirmala Sitharaman has sought to pass the blame for the Centre's failure to pay compensation on the pandemic, which she described as an "Act of God", that is not the whole truth.

The Centre first admitted to problems in paying compensation in September 2019 at the CGT Council meeting in Goa (it confirmed this in writing in November 2019).

Why did the Centre then cut corporate tax by Rs 1.45 lakh crore in the very same September 2019? Certainly, Sitharaman knew how dangerous it was.  

The tax cut was justified on the grounds that it would lead to higher investment and creation of jobs. The RBI's 2019-20 annual report, released on August 25, has revealed what happened to the tax cut: "The corporate tax cut of September 2019 has been utilised in debt servicing, build-up of cash balances and other current assets rather than restarting the capex cycle. These underlying developments suggest that the appetite for investment is anaemic and in need of more reforms."

Clearly, the Centre's claim turned out to be baseless and a reflection of fiscal mismanagement. Not to forget that the GDP was consistently falling from a peak of 8.1% in Q4 of FY18 to end up at 3.1% in Q4 of FY20. The lockdown began on March 25. By then the damage had already been done.

Sitharaman's suggestions to states to seek loan from the RBI to fill the gap defies logic as it constitutes a violation of law, Goods and Services Tax (Compensation to States) Act of 2017, morally wrong and threatens to derail "cooperative federalism".  

States are compensated for foregoing their taxing rights and loss of revenue. It is not a charity.

Section 8 of the GST Act says that an intra-state cess needs to be levied "for the purposes of providing compensation to the states for loss of revenue arising on account of implementation of the goods and services tax, with effect from the date from which the provisions of the Central Goods and Services Tax Act are brought into force, for a period of five years or for such period as may be prescribed on the recommendations of the Council".

Logically speaking, there are two additional reasons why the Centre should take loan and pay states: (i) Centre has to ultimately pay for the loans from its cess (ii) it is one-point borrowing and one-point paying for the Centre, which is far easier than 37 states and union territories doing it separately through 148 accounts which they wouldn't be paying back from their pockets in any case.

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