Goods and Services Tax, the new tax reform on cards, promises to bring the economy at par with other developed nations.
Tax policies in an economy play a major role through their impact on both efficiency and equity. A good tax system keeps in view, issues like equitable distribution of income and efficient allocation of resources, at the same time, generating tax revenues to support public services and infrastructure development. There have been various tax reforms in our country, from time to time, with the objective of improving efficiency, enhancing simplicity and ensuring compliance.
In a developing economy like ours, where resources are scarce and limited, the trade-offs between various policy objectives need to be handled judiciously. The various policy instruments and taxation policies should be such that they maximize economic efficiency and minimise distortions in effective resource allocation, capital formation and international trade.
With regard to equity, it has been widely acclaimed that horizontal equity is preferred over vertical equity. While vertical equity is based on high marginal rates of taxation in both direct and indirect taxes, horizontal equity relies on simple and transparent broad-based taxes, with low variance with respect to tax rate. This led India to make a shift in its taxation policies during the tax reform of nineties, when the tax regime relied heavily on indirect taxes. It exerted an adverse impact on prices through cascading effect and also on various sectors of production by reducing their competitiveness. This phenomenon significantly contributed to the loss of income and welfare in the economy.
The introduction of CENVAT at the central level (2002-03) and VAT at the state level (2004-05) helped overcome some of these challenges by removing the system of multiple taxation to some extent and also leading to high growth in the tax revenue. However, despite the success of VAT, there are certain shortcomings in the structure, both at the central and state levels, which the dual GST taxation system seeks to overcome.
The introduction of GST at the central level will be more comprehensive by inclusion of more indirect central taxes which have been left out by CENVAT. It would also integrate goods and service taxes for the purpose of offset relief and at the same time may also lead to revenue gain for the centre through widening of dealer base by capturing value addition in the distributive trade. Also, in the existing state-level VAT structure, there are a few loopholes. There are several indirect taxes on goods and services, which have not been included in the VAT scheme, for instance, entertainment tax, luxury tax etc. Moreover, there also exists cascading effect to some extent, within the existing structure, as the CENVAT load on goods remains included in the value of the goods to be taxed under state VAT. Additionally, there should be removal of cascading effect of service tax and integration of VAT on goods with tax on services at the state level as well.
GST provides a solution to all the above problems by resting additional powers in the hands of the states for the levy of taxation of services and by introducing a comprehensive system of offset relief, including offset for cascading burden of CENVAT and service taxes.
Furthermore, the system of GST seeks to increase compliance and reduce prices to some extent as both the central and the state taxes will be collected at the point of sale and will be charged on the manufacturing cost.
Thus, GST will not only redistribute the burden of taxation between manufacturing and services, but also enable the widening of tax base, further reducing the effective tax rate. It will help reduce distortions in the system and will facilitate investment decisions being made on purely economic concerns, independent of tax considerations.
This will create a truly unified Indian market, by enabling free trade and commerce throughout the country, unhindered by tax barriers and disparities and help India improve its brand image.
