What?

The Goods and Service Tax Bill or GST Bill, officially known as The Constitution (122nd Amendment) Bill, 2014, would be a Value added Tax (VAT) to be implemented in India, from April 2016. GST stands for “Goods and Services Tax”, and is proposed to be a comprehensive indirect tax levy on manufacture, sale and consumption of goods as well as services at the national level. It will replace all indirect taxes levied on goods and services by the Indian Central and State governments. It is aimed at being comprehensive for most goods and services.

How will the goods and sevices  tax (GST) work in India? How is it any different than the value added tax (VAT)?

The GST framework could easily be one of the most important tax reforms to be tabled for discussion in the parliament. It does bring with it some problems, like division of taxation powers between the central government and states. Not surprisingly, the Finance ministry has already missed three of its deadlines to come out with an acceptable framework. In fact, most of the proposals aren’t even in the beta stage yet. But, most administrators and more importantly, producers believe it would make the tax procedures more fair, transparent and efficient.

An ideal tax system collects taxes at various stages of production, supply and retail. It is based on the value that the producers, suppliers and retailers individually add to the product. However, the current tax regime is unfairly skewed against most producers. Let’s outline and simplify the current system of taxes to see how it operates:

Assume there is a soap manufacturer that procures raw materials at 500 lakhs per batch. The manufacturer keeps his operating profits at 100 lakhs and encumbers a processing cost of 50 lakhs. The flow would look something like this:

If we calculate the total tax that the producer has to pay in this case, it would be 120 lakhs (50 lakhs on procurement and 70 lakhs on sales). Now if you have a GST framework in place, the total tax that the producer pays is 70 lakhs.

How?

The producer had initially paid an input tax of 50 lakhs. Now when he goes on to sell his batch for 700 lakhs, he gets a tax credit of 50 lakhs. Thus, he pays 20 lakhs in the form of taxes for the final transaction. This adds up to just 70 lakhs for the producer. The GST hence, reduces the tax burden on producers. The biggest benefit of such a system is that it would contain various indirect taxes currently levied on various participants in the supply chain. Reducing such taxes would lower the overall production cost and  increase the output of the economy in the long run.

That sounds great, but, why GST when we already have VAT? Isn’t the VAT framework similar to that of GST? VAT regulations and rates generally vary across states. There is a tendency, as has been observed, that states may resort to undercutting of rates to attract more investors. This generally leads to a loss of revenue to both the state and centre. GST would introduce uniform taxation laws across states and different sectors. The taxes would be divided between the state and centre, based on a formula that would be acceptable to both. Also, it would be easier to supply goods and services uniformly across the country, as no additional taxes would have to be paid across different states. Currently, no tax credits are provided for interstate transactions.

So do we as consumers get goods at a cheaper price? Probably not, and it is here that the GST has been attacked by the opposition. Since taxes are distributed across the chain, the consumer prices are likely to rise to maintain the current tax revenue levels. The government has justified this by saying it would provide tax cuts across various brackets. This isn’t entirely satisfactory. First, the tax paying population isn’t too significant a number to begin with and second, the tax payer is likely to get a meager tax cut for the GST he would pay for all the goods or services he purchases.

GST is clearly a long term strategy, it would lead to a higher output, more employment opportunities, and economic inclusion. Initially however, it is likely cause high inflation rates, administrative costs, and face stiff oppositions from states due to loss of autonomy.

Sources:

• http://www.gstindia.com/how-different-is-current-gst-bill-from-its-2011-version-2/
• http://en.wikipedia.org/wiki/Goods_and_Services_Tax_%28India%29_Bill
• http://www.quora.com/How-will-the-goods-and-sevices-tax-GST-work-in-India-How-is-it-any-different-than-the-value-added-tax-VAT