Goods and Services Tax Blog

Regressivity of VAT-GST can be remedied at great cost

“Occupy the Wall Street” in the USA and similar protests in other countries in recent times show the people’s perception about the economic set up that it is unjust and is skewed against the poorer class. These upheavals are no less against the tax system also which is a key element in the economic set up. Indeed the whole world is burdened with GST, thanks to the motivation supplied by the IMF. Only exception is the USA.

About the regressivity of GST there is no doubt. When the ratio of consumption tax to income decreases it is called a regressive tax. A single rate of VAT with no zero-rate, except for exports, and few exemptions must mean that the VAT payments by low income households will be a higher proportion of incomes than payments by higher income households. That is, the VAT will be regressiveⁱ. Regressive tax is taken as unfair by people. The definition of fair is vague but it is well accepted that fairness must be interpreted relative to the extent a person derives benefits from the society. ⁱⁱIn England, Adam Smith laid down his concept of fairness in four canons, the first of which stated that taxes are fair when the tax burden is universal and applies equally to all in society. ⁱⁱⁱThe concept of proportional tax is fundamentally same as Adam Smith’s idea of fairness.

There are economists who argue that burden of a VAT levied at uniform rate would also be largely proportional if the denominator where lifetime income, rather than annual income became relevant because many income recipients are only temporarily in the lower income brackets. They move into middle or upper income brackets as their earnings increase^iv. This argument is more of semantics and is not accepted by those who are poor now. They refuse to believe that one day they will be rich and so the effect will even out. VAT is regressive for who are poor now. And the postulate that all poor will be rich one day is an utter trash.

There have been attempts to make VAT less regressive but there is a high cost of attaining it. There is a great administrative cost for trying to get progressivity by rate differentiation. The advantage of progressivity gained by a whole host of exemptions, zero rating and multiple rates is almost not certainly sufficient to offset the disadvantages associated with departure from a uniform rate and comprehensive base. Exemptions and differential rates distort consumer and producer choices, make for administrative complexity (and hence increased administrative and compliance cost) and raise questions of interpretation that often must be resolved in courts^v.

Any equity gains from differentiation of rates are likely to be more than outweighed by the additional administrative cost entailed. Exemption introduces cascading leading to major distortion and lack of neutrality, which is the virtue of VAT. In Turkey to achieve progressivity in 1991, the total VAT collection, as a percentage of total tax revenue itself was only 24% while half of it was given back as rebate to the lower income groups. This was done through a cumbersome mechanism that required monthly representation of receipts, their verifications, huge bureaucracy and a very high compliance cost^vi.

In this context we may judge the recent thesis by Michel J Graetz^vii that in the USA the threshold for income tax should be raised so that about 100 million tax returns become less. The loss of revenue could be made good by a comprehensive GST.

While reducing the number if returns of tax is a good idea, (more in vogue in the UK), the introduction of GST in its place is not so particularly because it will replace income tax which is a more progressive tax with consumption tax (GST) which is regressive.

A better switching of tax regime would be to raise the threshold for income tax and also raise the general rate somewhat.

The conclusion is that GST must be understood to be regressive and it should be more and more replaced by direct tax with higher threshold because that it a more progressive set up.

* Sukumar Mukhopadhyay, The Business Standard, January 02, 2012

i Alan A. Tait- VAT Policy Issues, p 5 in VAT Administrative and Policy Issues edited by Alan A. Tait IMF, 1991

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Commodities like petroleum, liquor should be brought under GST

The 115th constitutional amendment Bill introduced in Parliament to give effect to the introduction of the goods and service tax (GST) in the country keeps petroleum products comprising crude, diesel, petrol, natural gas and aviation turbine fuel as well as alcoholic liquor out of the purview of the proposed GST. These commodities are outside the purview of the value added tax (VAT) even at present and are taxed under the general sales tax regime.

Traditionally, petroleum products as generic inputs have been used as a proxy for taxing other commodities due to a weak tax collection mechanism and poor compliance. These, along with alcoholic liquor, treated as a sin good have been subjected to a high rate of tax. These commodities roughly contribute about a half of the consumption tax revenues of the states and attract a much higher rate of tax than VAT.

The states, therefore, are rightly concerned that bringing these commodities within the ambit of GST would bind them down to a common rate of tax that would be much lower than the prevailing rates, leading to a considerable loss of revenue and, more importantly, losing the power of the states to tax these products.

However, keeping them out of the purview of the GST will lead to two distinct tax regimes that would operate as separate silos. The inputs that go into the manufacture of these commodities would be taxed under the GST, the credit for which cannot be claimed under the statute of sales tax. This will lead to cascading, which is imposing a tax on a tax, the very problem that the GST seeks to set right.

Apart from the higher incidence of tax, the industry would also face the problem of maintaining a complex set of accounts across both the tax regimes making it cumbersome. More importantly, this would perpetuate the continuance of the central sales tax (CST), which is a perverse tax levied at the place of origin, which goes against the grain of GST that is a pure destination-based tax.

An elegant solution would be to bring these commodities under the ambit of GST, but allow for a provision that enables the states to impose an additional levy on these products. By bringing these commodities under the ambit of GST, it would be possible for the industry to seamlessly claim credit on the taxes already paid on the inputs to both the Centre and the states, thus avoiding a cascading of taxes and making the accounting process linear and simple.

By having an enabling provision to allow the states to impose an additional levy on these commodities, the powers of the states to tax these products will not be impinged upon and the revenue that the states have been getting from these commodities can be protected.

In the case of petroleum products, if the rate leviable under the state goods and services tax (SGST) is, say, 8% and the current levy of tax by the state, which includes sales tax and cess is, say, 30% on petrol, the states can allow for the levy of 8% on SGST that would allow the industry to claim input tax credit and collect the remaining 22% of the tax as an additional levy.

For alcoholic liquor, the states have an additional instrument in the form of state excise duty that can be used to raise additional levy. State taxes on alcoholic liquor at present broadly comprise of sales tax, additional sales tax on wholesaler, additional sales tax on retailer, surcharge, cess and excise duty.

Even if the sales tax imposed at all the different levels along with surcharge and cess are subsumed in GST, the states would still be able to raise the additional revenue by increasing the quantum of excise duty without any loss of revenue.

However, some states are wary of showing the actual amount of tax revenues earned from liquor as they do not want to portray that a large part of the states revenues accrue from the sale of liquor. Such a view can also be accommodated by allowing for an additional levy for alcoholic liquor, as in the case of petroleum products.

Suppose the sales tax on alcoholic liquor including all the surcharges and cess currently stands at 100% and the excise duty is, say, 20%, the industry can be allowed to take input tax credit by allowing for a SGST at the standard rate of 8%. The remaining 92% of the tax that the state needs to collect can be transferred as state excise duty, which would now stand at 112%.

Suppose the states are wary of projecting a large state excise duty earning, a provision can be made to impose an additional levy, through which the remaining 92% of the tax can be levied. Admittedly there are other ways of achieving the twin objectives of protecting revenue and autonomy of the state governments.

Amongst the obvious choices are denying tax credit on inputs and retaining the present taxation regime under general sales tax or to fix a high revenue-neutral rate under GST for these commodities and give the states the latitude to change the rates without reference to the GST council. However, both of them are not elegant solutions and would be cumbersome in working both for the government and the industry.

A mechanism of bringing these commodities within the purview of the GST and allowing the states to impose an additional levy would rationalise the plethora of taxes existing now, avoid cascading, enable clear and linear book-keeping and protect the authority and the revenues of the state governments.

* Suman Billa, The Economic Times, December 31, 2011.

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Nandan Nilekani to head SPV on GST network

The empowered group of state finance ministers on GST approved the setting up of a special purpose vehicle, called the GST Network, headed by Nandan Nilekani. The SPV will be responsible for implementing the IT infrastructure needed to roll out GST, one of the country’s most ambitious tax reforms.

“In today’s meeting, we have approved the SPV and requested Nilekani to go ahead with the IT infrastructure . The SPV would solely be responsible for running of the GST portal,” said Sushil Modi, chairman of the Empowered Group of State finance ministers. The States and Centre along with a technology company will be partners in the SPV. Modi, who is also the finance minister and deputy chief minister of Bihar, said the empowered group has also decided to submit its final report on GST to the standing committee of finance. The standing committee is examining the constitutional amendment bill on the issue. The GST roll out has missed several deadlines due to opposition from states.

“In the next 15-20 days we will submit a comprehensive report on GST to the standing committee detailing every issue where we have convergence with the Centre and points of difference,” Modi told TOI.

* Source: The Economic Times, October 14, 2011

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