Kelkar Shah Model: India’s GST & Tax Reform Blueprint

Summary: The Kelkar Shah Model, conceptualized by Dr. Vijay Kelkar in 2004, proposed a unified Goods and Services Tax (GST) for India. Its core objective was to integrate central excise, service tax, and state VAT into a single tax base, aiming to streamline the indirect tax system, reduce the cascading effect of taxes, and expand the tax base, drawing parallels with Canada’s Harmonized Sales Tax (HST). The model advocated for a dual GST structure, allowing both the Central (CGST) and State (SGST) governments to levy taxes on intra-state transactions, and emphasized a comprehensive tax base. While it initially suggested a single GST rate, the actual implementation in 2017 adopted multiple rates. Beyond GST, the model recommended simplified personal income tax slabs, a reduction in corporate tax rates, and the abolition of wealth tax, which was later enacted. Furthermore, the Kelkar Shah Model proposed broader fiscal reforms, including fiscal deficit reduction, rationalization of public expenditure, broadening the tax base, accelerating privatization, and managing public debt for long-term sustainability. The model provided a significant framework for India’s subsequent tax reforms and the eventual introduction of GST.

Kelkar Shah Model

The concept of Goods and Services Tax or GST was mooted by Dr, Vijay Kelkar former Finance Secretary in 2004.

Kelkar Shah Model of GST is a unified GST model which is based on a grand bargain to merge the central excise, service tax and state VAT to make it a common base for GST. As per this model, two different rates of tax are to be levied by the centre and the states, This is like the HST (Harmonised Sales Tax) model in Canada.

HST :-“The harmonised sales tax is a consumption tax in canada. It is used in provinces where both the federal goods and services tax and the regional provision sales tax have been combined into single value-added tax.”

The Kelkar-Shah Committee (2003) proposed a detailed model for the introduction of GST in India. The goal of the committee was to replace the existing complex system of indirect taxes with a single unified tax, which would enhance efficiency, reduce cascading (tax on tax), and increase the tax base.

The model sought to ensure that GST system was both revenue-neutral(not increasing or decreasing government revenue) and economically beneficial by simplifying the tax structure and minimizing distortions in the economy.

Key Features of the Kelkar Shah Model:

I. Dual Structure: The model suggest a dual GST system, where both the centre and states have the power to levy GST. This means there would be:

• Central GST (CGST) is the Central Government’s share of the GST levied on intra-state (within the same state) supplies of goods and services. CGST is collected by central government. It is applied when sale or supply takes place within a state or union territory.

Example:

If a seller in Mohali, Punjab, sells goods worth Rs. 10,000 to a buyer also in Punjab, and the GST rate is 18%, it will be divided as:

CGST = 9% = Rs.900 (goes to centre)

SGST = 9% = Rs.900 (goes to state)

• State GST (SGST) is the State Government’s share of the GST levied on intra-state supplies of goods and services. SGST is collected by the respective state government. It also applies to intra-state transactions (alongside CGST).

Example:

If a seller in Fatehgarh Sahib, Punjab, sells goods worth Rs. 10,000 to a buyer also in Punjab, and the GST rate is 18%, it will be divided as:

CGST = 9% = Rs.900 (goes to centre)

SGST = 9% = Rs.900 (goes to state)

II. Comprehensive Tax Base: The Kelkar Shah model advocates for a wide tax base, including most goods and services, to make the GST structure more efficient and transparent. This would help to reduce the cascading effect and improve compliance.

III. Single Rate System: The model proposes a single rate of tax for most goods and services to avoid the complexity of multiple tax rates, though it does allow for few exception in specific cases.

IV. Compensation Mechanism: It also emphasizes the compensation mechanism for state that may face revenue losses in the transition period post-GST implementation. This ensures that states are not financially disadvantages during the initial phase.

V. Simplification and Technology: The model stresses the need for simplification of tax procedures and use of technology to make the GST regime more efficient, with automation and a robust IT system to handle the vast volume of transactions.

Phases of the Kelkar-Shah Model:

1.Phase 1 : Initial Conceptualization & Framework ( institutionalization, drafting of laws, and designing the GST network).

2. Phase 2 : Pilot & Transition Period (Testing systems, awareness campaigns, and compliance systems).

3. Phase 3 : Full Rollout (implementation of GST rates, the dual tax structure, revenue-sharing, and the nationwide compliance).

4. Phase 4: Post – Implementation Review & Refinement ( Reviewing performance, making adjustments, and addressing practical issues).

 Tax Rate suggestions from the Kelkar Shah Model

 1. Personal Income Tax Rates:

• The model suggested simplified tax slabs for personal income:

• Implementation: The income tax slabs have been revised over time, but not exactly as suggested by the Kelkar model. For example, the tax rates were reduced in subsequent years, but with some variations in thresholds. However, there was a move towards reducing the tax burden on middle-income groups.

2. Corporate Tax Rates:

• The recommendation was to lower corporate tax rates to make India more globally competitive. The suggestion was around 30% for the most corporate entities.
• Implementation: Corporate tax rates were gradually reduced over time, though not exactly to 30%. Today, corporate tax for the most companies is 25% with smaller companies having lower rates.

3. Wealth Tax:

• The model suggested the abolition of wealth tax, as it was deemed inefficient and difficult to implement.
• Implementation: The wealth tax was abolished in 2015, aligning with the Kalkar model’s recommendations.

 Why abolish wealth tax?

The Kelkar committee argued that wealth tax was poorly structured and that it did not provide significant revenue to the government. Moreover, it was complex to assess and administer, especially because it applied to individuals who owned assets like l and, builing, stocks, and other valuables above a certain threshold. The exemptions and loopholes in the wealth tax law made it difficult to enforce effectively.

4. Goods and Services Tax (GST)

Kelkar Shah model suggestions:

• one single tax rate for all goods and services (simple and unified systems).
• Implementations:

GST was introduced in 2017, but multiple tax rates (5%,12%,18%,28%) were adopted instead of single rate. This was a deviation from the Kelkar model’s suggestion for a simpler, single-rate GST.

GST Structured Implemented:

• 5% for essential items.
• 12%, 18% and 28% for different categories of goods and services.
• Several exemptions were still present for certain sectors.

5. Excise Duty & Sales Tax (VAT)

Kelkar Shah Model suggestions:

• Simplification of excise duty and VAT by removing numerous exemptions and creating a more uniform tax structure.
• Implementation: with the introduction of GST, the previous excise duty and VAT structure was replaced, and many exemptions were indeed removed, but there is still some complexity in the GST system due to multiple rates.

Reforms of the Kelkar Shah Model:

1) Fiscal Consolidation and Deficit Reduction

• Reduction of Fiscal Deficit: One of the main recommendations was reducing the fiscal deficit ( the difference between the government’s expenditure and its revenue) to manageable levels. The target was to bring fiscal deficit down to 3% of GDP by 2008.
• Expenditure Rationalization: There was a push for reducing wasteful public expenditure, particularly in the form of subsidies, and reallocating those funds towards more productive uses.

2) Tax Reforms

• Simplifying the Tax systems: The report suggested simplifying and streamlining the tax system, including the introduction of Goods and Services Tax (GST), which at the time was still in the conceptual phase.
• Broadening the Tax Base: The idea was to improve tax compliance and reduce the reliance on a narrow base of taxpayers. This would help generates more revenue without increasing tax rates.
• Direct Taxes: recommendations included reducing corporate tax rates and restructuring income tax to make it more progressive and business-friendly.

3) Privatization and Disinvestment

• Privatizing Public Sector Enterprises: The Kelkar-shah model recommended accelerating the privatization of state-owned enterprises to reduce the government’s burden and improve efficiency in these companies.
• Disinvestments Strategy: A roadmap for disinvestment was suggested, with a focus on selling of public sector units to raise capital for the government.

4) Public Debt Management

• Reducing Public Debt: The report highlighted the need to bring down public debt, which had been rising as a share of GDP. This involved measures to reduce borrowing and shifting from short-term borrowing to more long-term, stable debt instruments.
• Sustainability of Borrowing: The model suggested that fiscal deficits and public debt need to be sustainable in the long-term, to avoid the risk of debt crises.