The greatest changes to ever occur in the Indian Economy in the last few decades are ‘Demonetization of Rs. 500 and Rs. 1000 currency notes’ and ‘The Introduction of GST’. Economists believe that these two steps, amplifying each other’s effects, will be a game-changing decision.
Demonetization has been extensively discussed and debated upon, so most of us might be aware about its implications. However, GST is still an unchartered territory. Let’s discuss what the GST fuss is all about.
Taxation is the basic source of revenue for the government of any country. These taxes can be classified into two types - Direct and Indirect Taxes.
Direct tax, i.e. Income tax, is a tax that is levied by the government to be paid by every person or institution in the country, subject to some exemptions. It is paid out of and in proportion to the income of the person or institution.
So if you ever come across people discussing about Income Tax Returns or ITRs, this is what they are talking about.
Indirect taxes are levied by the government on goods or services. They are paid by every person consuming such goods irrespective of their incomes. They are not directly paid to the government by the consumers, but collected by the suppliers of such goods or services from their customers (consumers) and subsequently paid to the government.
There are many indirect taxes in India, namely Service tax, Excise duty and Customs duty levied by the Central Government and Value Added Tax (VAT) levied by the respective State Governments.
You might remember that while eating at a restaurant, you eventually pay a little more than the prices you see on the menu. That is because of a little asterisk leading to Terms & Conditions that say ‘Taxes extra’.
How do Indirect Taxes work?
As we can see in the Diagram 1, the steel supplier, in this case, supplies steel to the automobile industry and collects indirect taxes from them, which are subsequently deposited to the government.
A Nation Without Credit
Assuming the sales tax rate is a mere 10%, imagine the life cycle of a piece of steel worth Rs. 100, originating from the mine and ending in the hands of the consumer. Have a look at Diagram 2.
The price of steel surged by a whopping 61% merely on account of taxes, in a case where:
• The tax rate has been assumed to be conservatively low (10%), and
• The number of intermediaries between the Mine Owner and Consumer have been assumed to be unrealistically low in a country as gigantic as India with 1.3 billion people.
• Value additions of intermediaries have not been factored into the calculation.
Concept of Credit
The government was conscious of this concern and provided for a benefit in the law, to curb this issue. The credit of input taxes was allowed to be set off against the output tax liability. This means that input taxes didn’t become a cost, but they were treated as an advance payment of output tax to the government. This ensured that in fact, at every stage, only the value addition was taxed.
In the above mentioned example about steel, if the benefit of credit was allowed, the basic sale price at every stage would have been Rs. 100 as the tax paid on inward supply wouldn’t become a cost for the person and would be set off against his output tax liability.
Problems with the Current Indirect Tax Structure
There are so many taxes in the current regime, which in itself is a huge issue that leads to business difficulties due to increased compliances. Adding to that, there is the looming issue that the Centre doesn’t allow set off of credit of taxes paid to the States on inward supplies (purchases) and vice versa.
This is a huge problem for businesses which have to pay Central taxes on outward supplies and State taxes on inward supplies (purchases) or vice versa.
This results in inflation in the economy and we all know that isn’t good.
GST: One Nation One Tax
The introduction of GST is a single move unifying all the indirect taxes under one umbrella. From the day GST becomes applicable, all other indirect taxes will be abolished. Since our government has a federal structure, 3 types of GST will be levied - Central GST (CGST), State GST (SGST) and Integrated GST (IGST).
GST will ensure free flow of credits throughout the supply chain as the credit of IGST can be utilised against CGST, SGST and IGST and vice versa. The only restriction in utilisation of credit is that CGST cannot be utilised against SGST and SGST against CGST.
However, this does not pose a problem as both CGST and SGST are applicable on the same transaction. So the CGST and SGST credits can be utilised against their respective output liabilities.
This is the main reason why GST has been proposed to be introduced in the economy. Economists predict that due to reduced compliances, free flow of credits and increased ease of doing business, the GDP growth rate can increase by a factor of upto 2%. Also, many MNCs which were reluctant to invest in India due to all these issues, will now be further encouraged.
Now when you hear about GST is the news, you’ll be able to appreciate all the effort that is being put in for making it a reality and you’ll understand what its consequences will be.