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At the very outset, the author of this write up wants to put a disclaimer that this article has nothing to do with the procedural or legal loopholes or shortcomings of the Indian GST, perceived or real, if any. It is not going to deal with the issues whether GST returns could be easier and more simple, why the GSTN is not performing as expected, whether the laws in respect of ‘input tax credit’ could be prone to frequent litigation, or for that matter whether valuation rules requires simplification or not. It is none of that. It is rather an attempt to analyse Indirect Taxes particularly Goods and Services Tax from an economic angle, from an angle of suitability or desirability in different economic scenario, as a tool of redistribution of wealth and from a different and broad perspective whether and to what extent Indirect Tax affects the standards of living of people from the middle or lower rungs of economic strata. We would also see whether in principle GST is a panacea for all ills or not. We would question whether everything about it is good, simple, nice and rosy or like the beautiful moon, it does indeed have some dark spots.

Taxes are basically of two types – progressive and regressive. A progressive taxation means that as a person’s ability to pay tax keeps on increasing, he should be paying more taxes. The tax rates increase with every higher slabs of taxable income. In simple terms, a person with higher ability to pay should pay proportionately higher tax and people with lower ability to pay should pay lower taxes. Generally direct taxes like personal Income Tax and Wealth Tax comes under this categorization. Principle of progressive taxation sometimes is also used as a tool to address the issues of income inequalities and redistribution of wealth. This goes along with the Canon of Equity propounded by the Economist Adam Smith which suggests that burden of taxation should be distributed on an equitable basis taking into account the ability of the tax payers to pay. Accordingly rich people should bear a heavier burden of tax leaving the poor with a lesser burden. However, progressive taxation has been sometimes criticized on the reasoning that it tends to stifle economic growth because it can weaken entrepreneurship, risk taking attitude and investment as the people in high income bracket generally carries on such activities.

On the other hand, regressive taxation means a tax which is levied uniformly irrespective of the taxpayer’s ability to pay. It takes out a larger percentage of income from economically weaker section as compared to high income earners and affects people with low income to a higher degree than people with higher income. In regressive taxation, there is an inverse relationship between the taxpayer’s ability to pay and the rate of tax. In simple words, regressive taxation puts more burden on the people with low levels of income.

Indirect taxation is generally regressive is nature. Be it Sales Tax, Value Added Tax, Excise Duty, Service Tax or the modern day Goods and Services Tax, all these are indirect taxes. It is termed as Indirect because the burden of payment is shifted, i.e. the person who pays it to the Government is generally an intermediary like a manufacturer, wholesaler, retailer or service provider who passes on the burden to the ultimate consumer.

Taxation policy plays a major role in the administration and development of a country. It is not a merely revenue generation tool. Yes, through its levy revenues are generated but the role of the taxation policy of a Government is not fettered by such standalone purpose. It plays a bigger role in giving a direction to the economy. Through it, efforts can be made to reduce the inequalities in income and redistribution of wealth. It can also help social welfare – either through discouraging consumption of certain products by levying high tax on it and also by channelizing a portion of the tax collections in social infrastructure like health, education and family welfare. Taxation policy can provide suitable incentives to selected sectors of the economy; it can encourage exports and thereby helps in garnering foreign exchange. Monitoring indirect taxation can help check inflation too.

Both Direct and Indirect taxes are essential to garner adequate revenues for a country to run. There need to be a balance between the two in different economic scenario and one need to complement the other. The proportion of these two obviously varies depending upon various factors. A vibrant wealthy economy would find it easy to bring in more revenue in the form of Direct Taxes whereas a developing economy might need to resort more to Indirect Taxes. It is very difficult to have a desired or optimum ratio of these two to be universally applicable. Nevertheless, the popular view in the 19th century was that the desired balance could be 50:50 but now-a-days it seems the preference is towards direct taxes.

It is generally witnessed that low income countries has a tax collection of about 15% of GDP whereas the percentage of tax to GDP for high income nations are generally more than 30%. India’s tax-to-GDP ratio is about 18% while as per IMF data, in 2014 for other BRICS countries it was 23% in Brazil, 20% in China, 19% in Russia and 29% in South Africa. However, it is very difficult to pronounce the optimum tax-to-GDP ratio but on a study of India’s tax-to-GDP ratio, it can safely be concluded that it is definitely on the lower side when compared to somewhat similar economies and also compared to OECD countries.

In the opinion of French Economist Thomas Piketty, income inequality in India is widening. India has a low tax-to-GDP ratio and there is little spending on health and education. He along with Lucas Chancel of Paris School of Economics had authored a research paper which suggests that much can be done to promote more inclusive growth in India. While one may have reservations on their research on several counts and may describe their findings ‘exaggerated’ or can question the inherent shortcomings of the data, assumptions and estimates used by them, the fact remains that the authors have touched a raw nerve. Their findings find concurrence in survey report published by Oxfam.

It seems that growing income inequalities in India is an unpleasant truth but possibly an undeniable fact. Economic theories suggest that a progressive taxation, with all its limitations, would be a better tool to address this issue of income inequality.

Given this background, one of the vital issues that crops up before the policymakers is whether India should emphasize more on Direct Taxation rather than Indirect Taxation and what should be the ideal ratio for that. It is a fact that the tax-to-GDP ratio of India is definitely lower vis-à-vis comparable economies and the share of Indirect Taxes, which is generally regressive and burdensome on the lower income group, is more. India’s direct-to-indirect tax ratio was as low as 13:87 in 1987 which has somewhat come to 30:70 in recent years. The ratio for OECD countries is just opposite – about 65:35 in favour of direct taxes.

As per budget data, collection of direct tax by the Centre in 2018-19 was to the tune of Rs. 11.37 lakh crore and the indirect tax collection was at Rs. 9.44 lakh crore. The ratio is about 55:45 in favour of direct taxes. However, this is the collection of the Union only, if one adds up the collection of the States, where almost the entire collection in through indirect taxes like Vat, State Excise Duties and GST, the balance will be heavily tilted towards Indirect Taxes. Taking the help of the data published in Annexure 7.5 of the 14th Finance Commission Report 2016-20, if a ratio between direct and indirect taxes in India is calculated, it comes to roughly 31:69.

It leads us to the inevitable question – does a developing country like India need to depend so heavily on Indirect Taxes?

Before going into the specifics which kind of taxation suits a developing economy, let us go through the general advantages and disadvantages of both these taxes.

Direct taxes are more equitable. It is generally progressive and therefore, based more on the principle of equity. Its progressiveness serves as a fiscal weapon to make an attempt to reduce income inequality and bring social equality. Its administration is economic. It can be used as an instrument of fiscal policy to control inflation. The disadvantages of direct taxes come in the form of possible tax evasion if the system is not water tight. It is also argued that direct taxes limit capital formation, is a disincentive for investment and affect motivation, willingness and ability to work hard which could stymie economic growth.

On the other hand, the merits of indirect taxes lie in its wide coverage; it can be used to restrict consumption of demerit goods and have huge revenue potential. However, the demerits of indirect taxes are that these are mainly regressive in nature and creates burden for the poor. Its collection is difficult to be predicted and therefore these suffer from elements of uncertainty. It could be a cause for inflationary tendencies and sometimes may lead to fall in consumption.

In a paper titled ‘Can progressive taxation contribute to Economic Development’ published in July 2008, authors Christian Weller and Manita Rao observed that progressive income taxation may be appealing especially in industrializing economies that often have highly unequal income distribution. According to a paper published in IMF’s Economic Issue No. 27, an ideal tax system in developing countries should raise essential revenues without excessive government borrowing and should do so without discouraging economic activities. Income tends to be unevenly distributed in these economies which call for taxing the rich more but economic and political power of the few rich prevents fiscal reforms. Therefore, in developing countries, tax policy is often the ‘art of the possible rather than the pursuit of the optimal’.

In an article titled Taxation for Developing Countries, authors Ehtisham Ahmed and Nicholas Stern of London School of Economics studied various ‘tax handles’ in the context of Indian economy. In their study, they found that the Indian example highlights some of the major policy issues and paradoxes. First, the move to direct taxes may be associated with a desire to link taxation to ability to pay and it is often claimed that indirect taxes are in-egalitarian. The validity of this claim depends on the context, and the Indian Indirect Taxation Enquiry Committee (1978) found the incidence of Indian indirect taxes during the mid-seventies to be quite progressive. A study prepared for the Indian Indirect Taxation Enquiry Committee [Government of India (1978)] in the late seventies remarked on the progressiveness of Indian indirect taxes. It has been argued that in practice the degree of progression that could be achieved through the sales tax is at the expense of complicated rate structures and exemptions, leading to revenue losses with little impact on “progressivity”.

In this particular backdrop and considering India’s increasing income inequalities, an attempt can be made to analyse the Goods and Services Tax. GST in India was a challenge straightway from its conceptualization in respect of policy perspective, federal structure of the country and operational and procedural functionality. It proposed to subsume Central Excise Laws which was more or less settled. It had to overcome the challenges of existing administrative mechanism of state vat and central excise. Probability of joint and concurrent jurisdictions loomed large. Keeping petroleum products outside its ambit made it a somewhat distorted one which was done more as an ‘art of the possible rather than the pursuit of the optimal’. There were doubts about curtailing state’s independence and dispute resolution systems. The threshold limit and compensation to states were some of the contentious issues. However, one can safely say that some of these bottlenecks have been overcome by the time GST was put in place.

Now the obvious question that comes to the mind is whether GST which is an indirect tax and is regressive in principle can be tweaked to inject a little bit dose of progressivity into it? Can a consumption tax like GST address the issue of growing income inequality? Since poverty alleviation remains the central theme of most of the welfare measures undertaken by the Government, can GST further its cause or becomes a hindrance to that?

However, the report of the Task Force of the 13th Finance Commission on GST does not think so. Their report says that in the Indian economic policy context, poverty reduction and inclusive growth are key policy objectives and will, undoubtedly, continue for some time. They raise a pertinent question about the implications of the switchover from the cascading and distortionary taxation of goods and services to the ‘flawless’ GST on economic growth, equity and poverty. Their report points out to the fact that in India, the motivation underlying the hugely differentiated scheme of indirect taxation of production and sales that has evolved over the country’s history was progressive and noble; the actual impact of such a structure is now widely acknowledged to be regressive, capricious, and sub optimal in terms of the efficiency of tax effort, leaving the door open for lobbyists and special pleading. Their observation in this regard is contradictory to that of the Indian Indirect Taxation Enquiry Committee finding. While the Indian Indirect Taxation Enquiry Committee (1978) found the incidence of Indian indirect taxes during the mid-seventies to be quite progressive (1978), the task force found the same to be regressive and even capricious. Their report suggests that the overall macroeconomic effect of reduction in economic distortions due to GST would be to provide an impetus to economic growth. Using Computable General Equilibrium (CGE) model, the NCAER study commissioned by 13th Finance commission shows that implementation of GST across goods and services is expected, ceteris paribus, to provide gains to India’s GDP somewhere within a range of 0.9 to 1.7 per cent. In respect of GST being pro poor, the task force is of the opinion that since all the food items distributed under PDS are proposed to be exempt from GST, the poor will not suffer any additional burden. Basic health, education and proposed inclusion of transactions in real estate under GST will also help the poor. The report concludes that the benefit to the poor from the implementation of GST will therefore, flow from two sources: first through increase in the income levels and second through reduction in prices of goods consumed by them. The proposed switchover to the ‘flawless’ GST should, therefore, be viewed as pro-poor and not regressive.

Theories apart, let us now turn to the ground realities. As per PIB release on the Union Budget 2018-19, the Tax GDP ratio of the Centre is about 12.1% as compared to 11.6% of the 2017-18 Revised Estimate. The Direct Tax to GDP ratio is 6.1% (6.0% in 2017-18 RE) and the Indirect Tax to GDP ratio is 6.0% (5.6% in 2017-18). It clearly shows that slowly the tilt is towards Indirect Tax, more precisely GST or the consumption tax.

The jury is unanimous on the issue that to address the issue of income equality, progressive taxation needs to be generally resorted to. This should be done mainly through personal income tax. But the question here is whether the personal income tax payer base in India is huge enough to address the issue of income equality.

As per Income Tax Return Statistics for the Assessment Year 2018-19 published by Income Tax Department (taking into account 5.87 crore properly filed and verified returns fulfilling consistency tests), out of 5.53 crore individual income tax returns filed, 4.74 crore returns declared Gross Total Income (before Chapter VI deductions) more than the threshold limit of Rs. 2.50 lakh. Out of this, 3.28 crore returns reported tax payable by them and the total tax payable by all such individual return filers was to the tune of Rs. 3.18 lakh crore only. Again out of this, only 1351 individuals declared income more than Rs. 5 crore and the total personal income tax of these 1351 returns was to the tune of Rs. 15,661 crore only. It thus appears that with such a base of personal taxpayers there will be little scope to use progressive taxation as an effective tool for reduction in income inequality. Any more increase in personal income tax on this existing base would shift the burden on the middle class taxpayers which would affect their purchasing power as well as the capability to save. This would squarely and adversely affect the collection of tax on consumption. In fact in 2019 budget, higher surcharge was proposed on tax payable by HNI having income of more than Rs. 2 crore which had to be rolled back ultimately. The natural remedy, therefore, seems to be rationalize the personal income tax slabs, broaden the base and be tough on tax evaders, particularly on the taxpayers belonging to the highest categories of income.

Under the circumstances, the obvious question that comes to mind is whether GST, being in principle a regressive tax, can fit the bill or not? Is it possible for the GST to fulfill the dual purpose of generating revenue as well as being pro poor or have some element of progressivity? The initial thought process of the Government seemed to point to that direction. Before the roll out of GST, at the time of finalizing the rates, the Council was subject to criticisms from various quarters for adopting multiple rate structures. The Finance Minister of that time, strongly defended the multiple-rate structure for the Goods and Services Tax (GST) saying, “different items used by different segments of society have to be taxed differently”.

Countering criticism from many quarters against levy of GST at many rates, the then Finance Minister cited examples of countries with 3-4 slab GST/VATs, even as some rich countries keep fewer slabs. Multiple rates, the finance minister said, are “inevitable” for India.

While adopting multiple GST rates, the justifications offered by the Government are that India, unlike other countries, needs to take care of its population which comes under various economic strata. Even for argument’s sake, the Government justification is accepted, where multiple rates are fixed for various types of goods and services depending on their use by section of the population having different economic capability, can that be a reason for charging different rates at least for the same goods or services? At that time, rate of GST were different for different types of restaurants (rationalized later) and one failed to understand as to why the rate of GST needs to be higher in an air conditioned restaurant. The same dish would obviously cost more in an air conditioned or a high end restaurant in the sense that the additional overhead expenses of a high end restaurant would naturally mark up the cost and make the food costlier consequently ensuring a higher amount of GST in absolute term. Whether having multiple rates of GST on different types of products and even having multiple rates for the same type of products helps in injecting a dose of progressivity is a matter of debate, it is beyond argument that such a structure invites complexities. The present GST in India is not ideal and in any case, it could not be ideal or ‘flawless’. However, in its present form it goes against the basic tenets and principle which require GST to be a simple tax and not burdensome – financially, procedurally as well from legal aspects. There need to be exemptions for most of the items of basic necessities predominantly used by the not so privileged class, a very nominal pro poor rate and possibly a higher and common rate for other goods and services. After justifying multiple rate structure, the Government also seems to be realizing that the time for rationalization of the rate structure has come and the Government now seems to be moving towards the same. It’s a universal truth – the simpler it is, the more will be compliance level.

Running a vast and developing country like India with all its complexities and the federal structure is a huge task. Keeping tax-to-GDP ratio reasonable, maintaining ideal ratio between direct and indirect taxes, addressing income inequality, maintaining the growth trajectory and providing its citizens a satisfied life to lead is indeed a tight rope job. No wonder, it is a perennial challenge for the policymakers and the policy executors.

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April 2024