GS Notes

6. Economics Notes 18

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Elaborate Notes

Indirect Tax: Concept and Characteristics

An indirect tax is a levy where the initial payer (the one on whom the tax is imposed) can shift the burden of the tax to another person. The core distinction lies between the ‘impact’ and ‘incidence’ of the tax.

  • Impact and Incidence:

    • Impact: Refers to the immediate point of contact where the tax is levied. It is the legal responsibility of a specific entity to pay the tax to the government. For instance, in the case of a sales tax, the impact is on the seller of the goods.
    • Incidence: Refers to the final resting place of the tax burden. It is the entity that ultimately bears the economic cost of the tax. In the sales tax example, the seller typically adds the tax amount to the price of the commodity, effectively shifting the burden to the final consumer. The incidence, therefore, is on the consumer.
    • Intermediary Role: The entity bearing the impact (e.g., the seller) acts as a tax collection agent for the government, collecting the tax from the person bearing the incidence (the consumer) and remitting it to the exchequer.

  • Regressive Nature: Indirect taxes are often considered regressive in nature. This is because they are levied uniformly on goods and services, irrespective of the consumer’s income. A tax on a basic commodity like salt or soap constitutes a larger proportion of a poor person’s income compared to that of a wealthy person, thus imposing a disproportionately higher burden on lower-income groups.

  • Key Examples of Pre-GST Indirect Taxes:

    • Excise Duty:

      • Definition: This was a tax levied on the manufacture or production of goods within the country. It was distinct from sales tax, which was levied at the point of sale.
      • Constitutional Mandate: The power to levy excise duty was primarily with the Central Government (Union List, Entry 84), except on alcoholic liquor for human consumption and narcotics, which were under the purview of State Governments (State List, Entry 51).
      • Challenge of Cascading Effect: A major flaw in the excise duty system was the ‘cascading effect’ or ‘tax on tax’. A manufacturer paid excise on finished goods, which included the cost of inputs on which excise had already been paid by the input supplier. This led to an inflationary spiral.
      • Evolution of Input Tax Credit:
        • MANVAT/MODVAT: To address the cascading effect, the government, based on the recommendations of the L.K. Jha Committee on Indirect Taxation (1976), introduced the MANVAT (Manufacturing Value Added Tax) scheme, which was later expanded and renamed as MODVAT (Modified Value Added Tax) in 1986. The MODVAT system allowed manufacturers to claim a credit for the excise duty paid on inputs and use it to offset the excise liability on their final product.
        • CENVAT: In 2000-01, MODVAT was rationalized and replaced by CENVAT (Central Value Added Tax). CENVAT aimed to simplify the system by introducing a more uniform rate structure and expanding the scope of eligible credits.
        • Subsumption into GST: CENVAT has now been subsumed into the Central Goods and Services Tax (CGST).

    • Customs Duty:

      • Definition: A tax levied on goods when they are transported across international borders (imports and exports). Import duties are more common and significant revenue sources than export duties.
      • Dual Purpose:
        1. Revenue Generation: It is a significant source of revenue for the Central Government.
        2. Trade Regulation: It serves as a key instrument of trade policy. High import duties can be used to protect domestic industries from foreign competition (protectionism), discourage the import of non-essential goods, and address trade imbalances.
      • Basis of Levy: In India, import duties are predominantly levied on an Ad Valorem basis, meaning they are calculated as a percentage of the value of the imported goods.
      • Octroi and Entry Tax: Analogous to customs duty at the national level, Octroi was a tax levied by local municipal bodies on goods entering their jurisdiction. Similarly, Entry Tax was levied by state governments on goods entering the state. These taxes were criticized for creating internal trade barriers and delaying logistics. Both have been subsumed under the State Goods and Services Tax (SGST).

    • Service Tax:

      • Introduction: Following the recommendations of the Raja Chelliah Committee on Tax Reforms (1991-93), which highlighted the need to tax the growing services sector, Service Tax was introduced in India in the budget of 1994-95.
      • Evolution of Tax Base:
        • Positive List (1994-2011): Initially, it was levied on a ‘positive list’ basis. The government specified a list of services that were taxable. It began with just three services: telephones, general insurance, and share broking. This list was expanded incrementally in subsequent budgets.
        • Negative List (2012 onwards): In 2012, the paradigm shifted to a ‘negative list’ approach. This meant all services were taxable by default, except for a specific list of non-taxable services (the ‘negative list’) and certain exemptions. This dramatically widened the tax base.
      • Rate and Subsumption: Before its subsumption into GST, the effective rate of service tax was around 15% (including cesses). It is now part of the GST framework.

The Goods and Services Tax (GST) Framework

GST is a comprehensive, multi-stage, destination-based tax that is levied on every value addition. It replaced a multitude of cascading indirect taxes levied by the Centre and State governments.

  • Historical Background:

    • Global Precedent: France was the first country to implement a GST system in 1954.
    • Indian Genesis: The idea of a national-level GST in India was first proposed by the Kelkar Task Force on Indirect Taxes in 2003. The process gained momentum under the Vajpayee government and went through extensive consultations and debates over the next decade.
    • Implementation: GST was finally launched in India on 1st July 2017, following the passage of the 101st Constitutional Amendment Act, 2016.

  • Taxes Subsumed under GST:

    • Central Taxes Replaced:
      1. Central Excise Duty (and related additional duties)
      2. Service Tax
      3. Additional Duties of Customs (commonly known as Countervailing Duty - CVD), which were levied to offset the excise duty paid by domestic producers.
      4. Special Additional Duty of Customs (SAD)
      5. Central Surcharges and Cesses related to goods and services.
      6. Central Sales Tax (CST) - levied by the Centre on inter-state sales but collected and retained by the originating state.
    • State Taxes Replaced:
      1. State VAT (Value Added Tax) / Sales Tax
      2. Entertainment Tax (except those levied by local bodies)
      3. Entry Tax (all forms) and Octroi
      4. Purchase Tax
      5. Luxury Tax
      6. Taxes on lottery, betting, and gambling
      7. Taxes on advertisements.

  • Commodities Excluded from GST (for now):

    • Alcohol for human consumption remains under the purview of State Excise Duty.
    • Five petroleum products: Crude Petroleum, High-Speed Diesel, Motor Spirit (Petrol), Natural Gas, and Aviation Turbine Fuel. The GST Council has the authority to decide the date from which these will be included in GST. Until then, they are subject to Central Excise Duty and State VAT.
    • Tax on the sale and consumption of electricity.
    • Real estate transactions involving the sale of land and buildings are subject to Stamp Duty, which is outside GST. However, GST is applicable on under-construction properties.
    • Securities transactions are governed by the Securities Transaction Tax (STT) and are not under GST.

  • Dual GST System:

    • Model: India adopted a Dual GST model, similar to Canada and Brazil, where both the Centre and the States simultaneously levy tax on a common base of goods and services. This model was chosen to uphold the principle of Fiscal Federalism.
    • Intra-State Transactions: For transactions within a state, two taxes are levied:
      • CGST (Central GST): Levied and collected by the Central Government.
      • SGST (State GST): Levied and collected by the respective State Government. (For Union Territories, it is UTGST).
    • Inter-State Transactions: For transactions between states, a single tax is levied:
      • IGST (Integrated GST): Levied and administered by the Central Government. The revenue from IGST is apportioned between the Centre and the destination state based on the recommendations of the GST Council. This ensures that the tax revenue accrues to the state where the goods or services are finally consumed (destination principle), unlike the earlier CST which was an origin-based tax.

  • Key Constitutional Amendments (101st CAA, 2016):

    • Article 246A: This new article grants concurrent powers to both the Parliament and the State Legislatures to make laws with respect to GST. However, Parliament retains exclusive power to legislate on inter-state supplies.
    • Article 269A: This article governs the levy and collection of IGST on inter-state trade. It specifies that IGST will be levied by the Centre but will be apportioned between the Union and the States as per the GST Council’s recommendations. Importantly, this apportionment happens outside the Consolidated Fund of India to facilitate a seamless transfer of funds.
    • Article 279A: This provides for the constitution of the GST Council, a joint forum of the Centre and the States.
      • Composition: Chaired by the Union Finance Minister, with the Union Minister of State for Finance and State Finance Ministers as members.
      • Voting Structure: The Centre has a one-third voting weightage, and all States combined have a two-thirds weightage. Decisions require a three-fourths majority.
      • Quorum: 50% of the total members.
      • Functions: It makes recommendations on key issues like tax rates, exemptions, threshold limits, and the inclusion of excluded items.

  • Other GST Mechanisms:

    • GST Composition Scheme: A simplified tax scheme for small taxpayers with a specified annual turnover. They pay tax at a fixed, low rate of turnover and have minimal compliance requirements. However, they cannot issue tax invoices (i.e., cannot collect tax from customers) and are not eligible for input tax credit. The scheme is not available for inter-state suppliers or e-commerce operators.
    • Reverse Charge Mechanism (RCM): In a departure from the normal mechanism where the supplier is liable to pay tax, RCM places the liability to pay tax on the recipient of goods or services. This is typically applicable in specific situations, such as when a registered business procures goods/services from an unregistered supplier.
    • National Anti-Profiteering Authority (NAA): Established as a statutory body under Section 171 of the CGST Act, 2017, to ensure that the benefits of tax rate reductions or input tax credits are passed on to the consumers by way of a commensurate reduction in prices. If profiteering is confirmed, the NAA can order the supplier to return the undue benefit, deposit it in a consumer welfare fund, or cancel the entity’s GST registration.

Prelims Pointers

  • Impact of Tax: The first point of contact where the tax is levied.
  • Incidence of Tax: The final entity that bears the economic burden of the tax.
  • Pre-GST Indirect Taxes: Excise Duty (on manufacturing), Customs Duty (on imports/exports), Service Tax, VAT, Octroi, Entertainment Tax.
  • MODVAT: Introduced in 1986-87, based on L.K. Jha Committee recommendations, to provide credit for excise duty paid on inputs.
  • CENVAT: Replaced MODVAT in 2001 with a more uniform rate structure.
  • Service Tax: Introduced in 1994-95, initially on three services.
  • Negative List Concept: Introduced for Service Tax in 2012, making all services taxable except those specified in the list.
  • First Country with GST: France (1954).
  • GST Implementation in India: 1st July 2017.
  • Constitutional Amendment for GST: 101st Constitutional Amendment Act, 2016.
  • Taxes subsumed by GST (Central): Central Excise, Service Tax, CVD, SAD, Central Sales Tax.
  • Taxes subsumed by GST (State): State VAT, Entry Tax, Entertainment Tax (except by local bodies), Luxury Tax, taxes on lottery and advertisement.
  • Items outside GST: Alcohol for human consumption, 5 petroleum products (crude oil, petrol, diesel, ATF, natural gas), and electricity.
  • Dual GST Model: Practiced by Canada, Brazil, and India.
  • Intra-State Supply: CGST + SGST/UTGST are levied.
  • Inter-State Supply: IGST is levied and administered by the Centre.
  • New Constitutional Articles:
    • Article 246A: Concurrent power for Parliament and State Legislatures to legislate on GST.
    • Article 269A: Levy and collection of IGST on inter-state trade.
    • Article 279A: Constitution of the GST Council.
  • GST Council Composition:
    • Chairperson: Union Finance Minister.
    • Members: Union MoS (Finance) and all State Finance Ministers.
  • GST Council Voting Rights:
    • Centre: 1/3rd of total votes.
    • States: 2/3rd of total votes.
    • Decision-making requires a 3/4th majority.
  • GST Council Quorum: 50% of the total members.
  • Reverse Charge Mechanism: Liability to pay tax falls on the recipient of goods/services instead of the supplier.
  • National Anti-Profiteering Authority (NAA): An institutional mechanism to ensure firms pass on the benefits of GST rate cuts to consumers.

Mains Insights

GST: A Paradigm Shift in Indian Taxation and its Implications

The introduction of Goods and Services Tax (GST) is arguably the most significant indirect tax reform in post-independence India. Its implications span across the economy, federal structure, and governance.

1. Rationale for GST: Addressing the Deficiencies of the Old Regime

The pre-GST tax structure was plagued by several issues that hampered economic efficiency and integration. Understanding these provides the context for the reform.

  • Cascading of Taxes (Tax on Tax): The system lacked a comprehensive input tax credit mechanism across the value chain. For example, a manufacturer paid Central Excise on goods, and when these goods were sold, the state levied VAT on a price that included the excise duty. This created a tax-on-tax effect, artificially inflating prices for consumers.
  • Economic Fragmentation: Taxes like Central Sales Tax (CST), Octroi, and Entry Tax created fiscal barriers between states, treating them as distinct economic zones. This fragmented the Indian market, hindered the free movement of goods, and increased logistics costs and transit times.
  • Multiplicity of Taxes and Complex Compliance: Businesses had to comply with a plethora of central and state taxes (Excise, VAT, Service Tax, etc.), each with its own laws, rates, and administrative procedures. This increased the compliance burden, especially for MSMEs, and led to litigation.
  • Lack of Uniformity: Tax rates and rules varied significantly from state to state, leading to rate arbitrage and distortionary business decisions (e.g., setting up warehouses in states with lower tax rates).

2. GST and Cooperative Federalism: A Double-Edged Sword

GST fundamentally altered the Centre-State fiscal relationship, presenting both an opportunity for cooperation and a point of friction.

  • Strengthening Cooperative Federalism:

    • The GST Council: Article 279A institutionalizes a unique federal body where the Centre and States are joint decision-makers. The voting structure (States: 2/3rd, Centre: 1/3rd; 3/4th majority for decisions) necessitates consensus-building, epitomizing cooperative federalism.
    • Uniformity: By creating a single tax structure, it has fostered economic union, a key goal of federalism.

  • Challenges to Fiscal Autonomy of States:

    • Erosion of Taxing Powers: States surrendered their autonomy to levy taxes on the sale of goods and services, a significant source of their revenue. They are now dependent on the collective decisions of the GST Council to alter tax rates.
    • Dependence on Centre: The administration of IGST and the compensation mechanism initially made states more dependent on the central government for timely fund transfers, as seen during the GST compensation cess disputes. While the compensation regime was for a limited period, the structural dependence on the Council remains.

3. Economic and Revenue Implications

  • Revenue Implications:

    • Initial Disruption: The transition to GST led to short-term revenue uncertainty and disruptions for both the Centre and states. The need for a Compensation Cess was a direct admission of this anticipated revenue shortfall for states.
    • Long-term Buoyancy: Over time, GST revenues have shown buoyancy, driven by increased formalization of the economy, wider tax base, and improved compliance through digital tracking (GSTN, E-way bills). This has led to a more stable and predictable revenue stream.
    • Formalization of the Economy: The input tax credit mechanism incentivizes businesses to transact with registered suppliers, bringing more entities into the formal tax net. This has improved data availability for policymaking and financial lending.

  • Impact on Competitiveness and Ease of Doing Business:

    • ‘One Nation, One Market’: The subsumption of inter-state barriers like CST and entry taxes has streamlined logistics, reduced transportation costs, and allowed for the creation of more efficient, pan-India supply chains.
    • Simplified Compliance (in theory): The goal was a single return and a unified portal (GSTN). However, initial technical glitches and multiple compliance requirements (e.g., GSTR-1, GSTR-3B) have posed challenges, especially for small businesses.
    • Mitigation of Cascading Effect: A seamless flow of input tax credit across the value chain has eliminated the tax-on-tax effect, making Indian goods and services more competitive both domestically and internationally.

4. Governance and Administrative Aspects

  • Technology-Driven Governance: The Goods and Services Tax Network (GSTN), a robust IT backbone, is central to the GST architecture. It facilitates registration, return filing, and tax payment, enhancing transparency and reducing human interface, thereby curbing corruption.
  • Role of Anti-Profiteering Authority: The NAA represents a governance intervention to protect consumer interests by ensuring that tax reductions translate into lower prices. However, its functioning has been debated, with critics arguing about the difficulty in determining ‘commensurate’ price reduction and potential overreach.
  • Challenges in Implementation: The complexity of multiple tax slabs (0%, 5%, 12%, 18%, 28%), frequent changes in rules and rates, and technical issues with the GSTN portal have been persistent challenges in the implementation journey.

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