At the outset, it needs to be stated that what is called Goods and Service Tax is based entirely on a system of Value Added Tax. There are reasons to use this particular term in India, which need not concern us here. However, even in countries where it is called VAT, the tax is not just on goods, but also on trade and services.
The three essential benefits of GST have been stated in a September 2010 OECD paper by Alain Charlet and Jeffrey Owens as follows:
• The VAT raises revenue in a neutral and transparent manner. Some suggest that “a VAT is the most effective instrument for generating government revenue” and that “the marginal cost of raising funds for public purposes through VAT is generally lower than it would be if other taxes were employed.”
• VAT is relatively secure from serious fraud in a domestic market. The tax relies on a staged collection mechanism in which successive taxpayers are entitled to deduct input tax on purchases and have to account for output tax on sales.
• According to independent studies, the implementation of a unique VAT rate should reduce business compliance costs by at least 20% and up to 30%, and this may increase growth by 0.1% to 0.7%.
The full paper is available at https://search.oecd.org/ctp/consumption/46073502.pd
The advantages as above can be realised only when the application of the tax is done in the simple form that it is designed for. The simplicity ensures compliance, and, along with severe penalties, will reduce the possibility of fraud to the minimum. Hence the government machinery will have the resources to go after the evaders.
WHY THE SYSTEM IS COMPLEX
The complexity of the system as is being implemented is based on two primary factors. One is to achieve a social objective of equality, and the second is the lack of trust that the government exhibits vis-a-vis the citizens. The social objectives are stated in emotional terms that touch people’s hearts and thus make the mind accept it as valid. Lack of trust is a legacy of the colonial system and implemented in an independent country on the basis of socialism.
In justifying the multiplicity of tax rates, the Finance Minister wondered how an automobile and a Hawaii chappal can be taxed at the same rate. The latter is in the basket of the purchase by a poor man, while the one who purchases a car can afford to bear a higher tax. This justification has been made very often in the past in many countries, and it does have a theoretical justification. What it does not consider is that tweaking a system has a problem of its own, and often what is good in theory turns out to be not so practical. Who is to define what is a necessity and what is a luxury? And, what is considered to be a luxury today has often been found to be a necessity tomorrow.
At an aspirational level, a person who today can afford to buy only Hawaii chappals can well be a consumer for an automobile in a short period of time. We have so often come across stories of rags-to-riches, and a higher tax rate on a supposed luxury may well make the poor person to suppress his aspirations, which can motivate him to work harder.
WAGE GOODS MODEL
Here, let me very briefly discuss the Wage Goods model proposed by Professors C.N. Vakil and P.R. Brahmanand. This was postulated as something that needs to be done in addition to the Capital Goods model proposed by Professor P.C. Mahanalobis. In the Wage Goods model, it is proposed that serious effort should be made to provide goods, primarily of day-to-day necessities, which a person can buy through the wages he earns. The intention to state what was obvious, was that the government should identify if there are any hurdles that come in the way for such goods to reach the wage-earner. Essentially, it is not just a production issue but also a supply-chain issue, so that the producer can easily reach the consumer. Part of the supply-chain also deals with the wholesale and retail sector, and regulations should not come in the way for the players here to function efficiently.
I would like to extend the Wage Goods model also as a means to incentivise the wage-earner to make extra efforts to increase his wages. Suppose the wage-earner has a desire to buy a certain product. He presently is able to afford to buy the product if the price is Rs 40,000. However, suppose the producer needs a price of Rs 60,000 to make normal profits. The wage-earner may say he can make the extra effort to earn the additional Rs 20,000, benefitting the economy to this extent.
Another scenario is that the producer says that he needs a price of Rs 80,000. The wage-earner may feel that the extra effort needed is not commiserate with the benefits of the purchase. And so he stays where he presently is, and the benefit to the economy does not accrue.
So, if the automobile becomes out of reach to the wage-earner, due to extra taxation, then the expected increase in GDP, as mentioned in the third point earlier will not accrue.
Secondly, a lower tax on Hawaii chappals also means that there would be a higher tax on a host of other products that the chappal purchasing wage-earner would be buying. In which case, the net benefit for a lower tax on the chappals is negated, and looking at chappals in isolation would mean missing the forest for the trees.
The emotional appeal of the Finance Minister’s statements has to be moderated with reality, and recognising that the attempt to do fine-tuning could actually make things worse. It should also be remembered that the rich are also consumers of Hawaii chappals, and thus they get an unintended benefit.
The emotionalism is not restricted to the political class. Some social activists also express their own agenda in a similar way. For example, it is said that taxing the wheelchair used by a physically handicapped person means that there is a tax on walking. Considering the need to tax on the other day-to-day commodities that everyone buys, including the handicapped person, to be taxed higher to make up for the loss of revenue on wheelchairs, the net benefit to the handicapped person would be illusory. It has to be remembered that a purchase of a wheelchair is perhaps once every three to five years. Additionally, the other members of the family would be paying more for the products that have to be taxed higher.
INTRUSIVE MONITORING SYSTEM
A multiplicity of tax rate necessitates the need to monitor the system in an intrusive way. Misclassifying the product to avail of a lower rate is evasion of tax that would reduce the expected collection. Also, as has been seen in so many cases in the past, the maximum number of cases in the courts relate to classification disputes and not on the value of the goods or services. Multiple rates lead to a lot of discretionary power in government.
The cost of an intrusive system is an increased expenditure on bureaucracy, as well as reducing the ease of doing business. The former means the government needs a higher revenue, and thus a higher tax rate. The latter means an increased cost of operation, pushing up the prices. The third benefit mentioned by Charlet and Owens will not be achieved. The supposed social objective of the multiple rates will be illusory.
GOLWALKAR ON TRUST
The second basis for the complexity in the system is the lack of trust in the citizens of the country. While we lament that the British left us with a system of control, we forget that we had a choice of either continuing it or dismantling it when we achieved our Independence. Any coloniser has to, by definition, be very suspicious of those who they are ruling, because the ruled always aspires to remove to yoke of colonisation. We should also not forget that while the British applied a system of control on their colonies, they based the system in their own country on the basis of trust.
In this respect, I would like to quote a reply given by the second Sarsanghachalak of the Rashtriya Swayamsevak Sangh, Guruji Golwalkar, when he was asked: What happens if a particular farmer does not oblige? Secondly, if, as you said, there were to be free trade, where is the guarantee that the traders will distribute the food properly?
This was in context of the serious shortage of food in India, when there was talk about nationalising the food supply chain. The general charge was that it is the traders and the large farmers who were withholding the produce from coming in the market to create a shortage, when the fact was that there was a failure of crops.
The Sarsanghachalak first put the issue in the proper context, when he said: Quite an amount of odium has been heaped on the dealer. All right, let’s suppose that all our dealers are dishonest and have no thought of their brethren. Many people have been saying that all those who are engaged in industry, are also dishonest. Then there are persons who say that the labour is not putting the efforts it should. The work which they turn out does not bear any comparison to the time they have given. And there has been a talk that some farmers have been successful in suppressing their produce, and are not allowing it to come into the free market…
Having framed the issue thus, he proceeded as follows: Thinking in this way we may come to the conclusion that in this great wide country, there is not one honest soul; I think this is a very uncharitable view. And if there is no honest soul, where do we get honest souls from, even to man state trading? So we have to put some faith in one another.
As a matter of fact, our life can go on only if we have faith in one another. Let us take the dealers into confidence, all the villagers into confidence, all the people into confidence, to achieve all that, we want.
WHAT PEOPLE IN BUSINESS THINK
Sometime last year, a person from KPMG, a multi-national audit and consulting firm, came to meet me to seek business from our group. In the course of a discussion on ease of doing business, I said to him that the rules have to be made on the basis of trust. He said: “But people cannot be trusted.” To which the obvious answer was: “Then why should I trust you?”
At another point, I said that rules have to be simplified so that they are easy to follow. Most surprisingly, he said: “If things are simple, then I am out of a job.” I just had to reply to him as follows, “Then you are earning your salary on the basis of my misery.”
It is not just those in the government that want to make life difficult for businesses, it seems to me that there are many in the business of advising the government not to make life easy for business. And this person from KPMG had come to me to seek business from our group. For him to even think that this is the way to sell his services shows a level of arrogance that is quite amazing.
CHASM HAS TO BE CROSSED IN ONE STEP
Many people have said that eventually the rate for GST would be a uniform one. However, as has been said, you cannot cross a chasm in two steps. A uniform rate is not boldness at all—it is a necessity. It has a strong theoretical and empirical backing. In fact, the complexity in the system as is being implemented, may well make people hark back to the older system. Not because it was better, but because it was less complicated.
When the excise duty, in the mid-1980s, was converted from a cascading system to a value-added system, due the inherent lack of trust in citizens, that too was made complicated at the beginning and eventually simplified. The full advantage to the economy was delayed. It seems that we intend to repeat the mistakes of the past and then take the same steps of rectification that were taken in the past.
When Maharashtra was converting its sales tax system into a value added tax system, I had met some small business people and traders at Roha, a small town on the Mumbai-Goa highway. At the time there was opposition to the introduction of VAT. I asked those who had experience with the Mod-VAT in Excise what they felt about it. They said that in the form prevalent it was simple and also, more importantly, reduced the corruption inherent in the earlier tax form. What they were objecting to was the control system, which would have made the inspector-raj even more problematic. This anecdote should make policymakers realise that the people at large are ready to work with the government, if there is adequate reciprocity.
REFORMATIVE TAX THAT NEEDS TO BE SIMPLE
GST is indeed a reformative tax. Also, submerging so many taxes into one is a step that has not been adequately commented upon. So, when the removal of check-posts reduced the travel time for trucks, there was a mild expression of surprise. In fact, given what was being implemented, if the time had not reduced, it would have been a surprise.
Understanding the simplicity obviates the need to do away with an intrusive control system. When I talk to my industry colleagues, there is not sufficient recognition that the VAT system is such that it actively discourages avoidance and evasion. In fact, to stay in business, manufacturers, service providers and traders will actually find it worthwhile to be in a tax-paying chain. For this to happen, we need to avoid emotionalising some of the issues and base the system on trust.
Ashok Chowgule is a businessman based in Goa.