6. Economics Notes 19

Elaborate Notes

GST- Positives & Negatives

The Goods and Services Tax (GST), implemented on July 1st, 2017, through the 101st Constitutional Amendment Act, 2016, represents the most significant tax reform in post-independence India. It subsumed a multitude of central and state indirect taxes into a single, comprehensive tax structure.

Positives of GST

Simplification of Tax Administration: Before GST, the indirect tax system was fragmented and complex, comprising Central Excise Duty, Service Tax, Countervailing Duty at the central level, and Value Added Tax (VAT), Octroi, Entry Tax, Luxury Tax, etc., at the state level. GST replaced these with a unified system (CGST, SGST/UTGST, IGST), simplifying compliance. The entire process, from registration to filing returns and making payments, is managed through the Goods and Services Tax Network (GSTN), a robust end-to-end IT infrastructure, which significantly eases administration for both taxpayers and tax authorities.
Removal of Cascading Effect: The pre-GST regime suffered from a “tax on tax” or cascading effect, where a tax was levied on a price that already included previous taxes. For instance, VAT was often charged on a value that included the Central Excise Duty. GST eliminates this by allowing for a seamless flow of Input Tax Credit (ITC) across the entire supply chain, both for goods and services. This ensures that tax is levied only on the value added at each stage, increasing tax efficiency.
Creation of a Common National Market: By subsuming various state-level taxes like entry tax and octroi, GST has dismantled fiscal barriers between states. This has transformed India into ‘One Nation, One Tax, One Market’. It facilitates the free movement of goods across state borders, reducing transport and logistics costs.
Boost to Logistics Efficiency: The removal of state-level check posts and the introduction of the electronic E-Way Bill system have drastically reduced transit times for freight. This has improved turnaround times for trucks and optimised supply chains, contributing to lower logistics costs, which in India are notoriously high compared to global benchmarks.
Enhanced Ease of Doing Business: A simplified tax structure, uniform procedures, and a common online portal (GSTN) have reduced the compliance burden on businesses. This transparency and predictability have improved India’s ranking in the World Bank’s ‘Ease of Doing Business’ report, particularly under the ‘Paying Taxes’ indicator.
Widening of Tax Base and Formalisation: The requirement for ITC claims to be matched between suppliers and recipients has incentivised businesses to register under GST and declare their transactions. This has brought a significant number of informal sector enterprises into the formal economy, leading to a substantial increase in the number of new tax registrants.
Transparency and Leakage Control: The IT-driven nature of GST, with digital invoices and cross-matching of ITC, makes it difficult to evade taxes. This enhances transparency and helps curb leakages and corruption that were prevalent in the earlier manual tax administration systems.
Tax Democracy and Structure: The multi-tiered tax structure (0%, 5%, 12%, 18%, 28%) is designed to be progressive. Essential goods and services of mass consumption are placed in lower tax brackets or are exempt, while luxury and ‘sin’ goods are taxed at the highest rate, sometimes with an additional cess.
Promotion of Cooperative Federalism: The GST Council, established under Article 279A of the Constitution, is a prime example of cooperative federalism. It is a joint forum of the Centre and the States, where decisions on all key aspects of GST (tax rates, exemptions, rules) are taken through consensus, with the Centre having one-third of the voting power and the states having two-thirds.

Challenges of GST

Structural Complexities: Despite the ‘one tax’ moniker, GST has multiple rates, which some critics, like Dr. Vijay Kelkar (who headed the 2004 Task Force that first proposed GST), argue complicates the system. Furthermore, key items like petroleum products, alcohol for human consumption, and electricity remain outside the GST ambit, undermining the goal of a truly comprehensive indirect tax.
High Revenue Neutral Rate (RNR) Concerns: In the initial phase, the RNR—the rate at which tax revenue would remain the same post-GST implementation—was perceived to be high. This was done to ensure revenue security for both the Centre and states but led to concerns about its inflationary impact in the short term.
Anti-Profiteering Clause: The provision for an anti-profiteering authority (National Anti-profiteering Authority, NAA) was introduced to ensure that businesses pass on the benefits of reduced tax incidence (due to ITC) to consumers. However, it was criticised by industry bodies as a discretionary tool that could lead to a “license raj” environment, involving price controls and inspector oversight.
Federal Tensions: The consumption-based nature of GST raised concerns for manufacturing-heavy states. Moreover, issues surrounding the delayed payment of compensation cess to states, particularly during the COVID-19 pandemic, created friction and strained Centre-State financial relations. The voting structure of the GST Council, while promoting consensus, has also been criticised for potentially favouring the Centre’s position.
Complexity of IGST: The Integrated GST (IGST) model, designed to tax inter-state transactions, involves a clearing-house mechanism for settling funds between the Centre and the destination states. This system, while technologically sound, can appear complex and has faced initial technical glitches.

GST Compensation Cess

Rationale: GST is a destination-based tax, meaning the tax revenue accrues to the state where the goods or services are consumed. The earlier regime, particularly with Central Sales Tax (CST), was origin-based, benefiting manufacturing or ‘producer’ states like Gujarat, Maharashtra, Tamil Nadu, Karnataka, and Haryana. To persuade these states to join the GST regime, the Centre constitutionally guaranteed compensation for any revenue shortfall for the first five years.
Legal Framework: The GST (Compensation to States) Act, 2017 provides the legal backing for this mechanism. It calculates the potential revenue loss by projecting a 14% annual growth rate over the base year revenue of 2015-16 for each state. The shortfall between this projected revenue and the actual GST revenue collected by the state is paid as compensation.
Funding and Duration: The compensation is funded by levying a Compensation Cess on select ‘sin’ and luxury goods, such as pan masala, tobacco products, aerated water, and certain automobiles. The cess was originally mandated for the first five years of GST implementation, i.e., from July 1, 2017, to June 30, 2022.
Extension of Cess: Due to the economic slowdown and the COVID-19 pandemic, GST collections faltered, and the Compensation Fund proved inadequate. To meet its obligations, the Centre facilitated back-to-back loans for the states. To repay these loans, the GST Council decided to extend the levy of the Compensation Cess until March 31, 2026. However, it is crucial to note that the compensation payments to states ended in June 2022; the cess is now being collected solely to service the debt incurred.

E-Way Bills

Definition and Purpose: An Electronic Way (E-Way) Bill is a digital document generated on the GST portal for the movement of goods. It is mandatory for the inter-state or intra-state movement of goods valued at over ₹50,000. Its primary purpose is to track goods in transit to prevent tax evasion and ensure compliance with GST laws.
Mechanism: When an E-Way Bill is generated by the supplier, recipient, or transporter, a unique E-Way Bill Number (EBN) is created. This EBN must be available to the supplier, recipient, and the transporter carrying the goods. This digital trail replaces the physical transit passes and check-posts of the earlier era.
Impact on Logistics: The E-Way Bill system has been instrumental in facilitating faster movement of goods. By digitising the process and eliminating physical verification at every state border, it has reduced vehicle stoppage times, improved fleet utilisation, and contributed to a more efficient national logistics network, aligning with the objectives of the National Logistics Policy.
Enforcement: Non-compliance carries strict penalties. Transporting goods without a valid E-Way Bill can attract a penalty of ₹10,000 or the tax due, whichever is higher. In more severe cases of tax evasion, the goods and the vehicle used for their transport can be detained or seized.

Types of Taxes- Direct Tax

A direct tax is a tax where the liability to pay the tax (impact) and the actual burden of the tax (incidence) fall on the same person or entity. The burden cannot be shifted to others. The Central Board of Direct Taxes (CBDT) is the primary administrative body for direct taxes in India, which are governed by the Income Tax Act, 1961.

Major Direct Taxes of the Central Government:

Income Tax: Levied on the income of individuals, Hindu Undivided Families (HUFs), partnerships, etc. It is a progressive tax, meaning the tax rate increases as the income increases, based on different income slabs. However, after reaching the highest slab (e.g., 30%), the tax rate becomes constant, which can be described as proportional rather than purely progressive at very high-income levels. An additional surcharge is levied on high-income earners (e.g., those earning above ₹50 lakhs).
Corporate Tax: This is the income tax paid by domestic and foreign companies on their profits. The Income Tax Act, 1961 governs its levy. To make India a more attractive investment destination, the government, through the Taxation Laws (Amendment) Act, 2019, significantly reduced the base corporate tax rate to 22% for existing domestic companies (who do not avail specified exemptions) and to 15% for new domestic manufacturing companies.
Minimum Alternate Tax (MAT): This was introduced to address the issue of ‘zero-tax companies’—companies that made substantial book profits and paid dividends to shareholders but paid negligible or no corporate tax by taking advantage of various exemptions, deductions, and depreciation allowances available in the Income Tax Act. MAT is levied under Section 115JB of the Act at a rate of 15% (plus cess and surcharge) on the company’s ‘book profit’ if the tax payable under normal provisions is lower than the MAT amount.
Capital Gains Tax: This tax is levied on the profit (or ‘capital gain’) realised from the sale of a ‘capital asset’. Capital assets include property, land, buildings, vehicles, patents, trademarks, shares, bonds, and jewellery. The tax is categorised based on the holding period of the asset:
- Short-Term Capital Gains (STCG): Arise from the sale of a short-term capital asset. The holding period to qualify as ‘short-term’ varies:
  - Not more than 12 months for listed securities (shares, debentures).
  - Not more than 24 months for immovable property (land, buildings).
  - Not more than 36 months for other assets (e.g., unlisted shares, jewellery). STCG is either taxed at a concessional rate of 15% (if Securities Transaction Tax - STT is applicable) or added to the individual’s total income and taxed at their applicable slab rate.
- Long-Term Capital Gains (LTCG): Arise from the sale of an asset held for longer than the periods mentioned above. LTCG on immovable property and unlisted securities is generally taxed at 20% after indexation benefits (adjusting the purchase price for inflation).
Fringe Benefits Tax (FBT) & Banking Cash Transaction Tax (BCTT): These were historical taxes.
- FBT (2005-2009): Taxed employers on non-monetary benefits (perquisites or ‘fringe benefits’) provided to employees, such as club memberships, company cars, etc. It was abolished due to its complexity and unpopularity with corporations.
- BCTT (2005-2009): A minor tax (0.1%) on cash withdrawals from banks above a certain threshold. It was introduced by P. Chidambaram to track unaccounted money and large cash transactions but was later withdrawn.

Taxes on Wealth and Capital

These taxes are levied on the holding of wealth or the transfer of capital, distinct from income.

Wealth Tax (Abolished): Introduced in 1957, it was an annual tax levied on the net wealth of individuals, HUFs, and companies. In its final form, it was levied at 1% on net wealth exceeding ₹30 lakhs. Finance Minister Arun Jaitley abolished it in the 2015 Budget, citing that the cost of collection was disproportionately high compared to the revenue it generated. It was replaced with an additional surcharge of 2% on the super-rich with an income of over ₹1 crore.
Dividend Distribution Tax (DDT) (Abolished): This was a tax paid by a company on the dividends it distributed to its shareholders. It was a tax levied at the source, and the dividends were then tax-free in the hands of the investor. Proponents argued it was easy to collect. However, it was criticised for violating the principle of equity, as all shareholders, regardless of their income level, effectively paid tax at the same rate. In the Union Budget 2020, Finance Minister Nirmala Sitharaman abolished DDT and reverted to the classical system, where dividends are taxed in the hands of the recipient at their applicable income tax slab rates.
Estate Duty (Abolished): Also known as inheritance tax, it was introduced in 1953 and was levied on the total market value of all assets ‘passing on’ to heirs upon a person’s death. The rationale was to reduce the concentration of wealth passed down through generations. It was abolished in 1985 by V.P. Singh, primarily due to complexities in valuation, prolonged litigation, and very low revenue yield. There is a recurring academic and political debate about its reintroduction to tackle rising wealth inequality, a point highlighted by economists like Thomas Piketty in his work “Capital in the Twenty-First Century” (2013).
Gift Tax: Originally introduced as a separate Act in 1958 and later integrated into the Income Tax Act, 1961 (Section 56(2)). It is designed to prevent tax evasion by disguising income transfers as gifts. Any sum of money or property received by an individual without consideration, the aggregate value of which exceeds ₹50,000 in a year, is taxed as ‘Income from Other Sources’. However, there are significant exemptions. Gifts are not taxed if received:
- From any ‘relative’ (defined specifically in the Act, including spouse, siblings, parents, etc.).
- On the occasion of one’s marriage.
- By way of a will or inheritance.
- From a local authority or approved charitable/educational institution.

Budget- Annual Financial Statement

Constitutional Provision: The term ‘Budget’ is not explicitly used in the Indian Constitution. Article 112 of the Constitution mandates the President to lay before both Houses of Parliament a statement of the estimated receipts and expenditure of the Government of India for that year. This statement is called the ‘Annual Financial Statement’.
Structure: The budget is broadly divided into two main components: Receipts and Expenditure.
- Receipts: These are inflows of money to the government. They are classified into:
  1. Revenue Receipts: These are receipts that neither create a liability nor lead to a reduction in the government’s assets. They are regular and recurring. They include Tax Revenue (e.g., Income Tax, GST, Customs Duty) and Non-Tax Revenue (e.g., interest receipts on loans, dividends from PSUs, fees, fines).
  2. Capital Receipts: These receipts either create a liability for the government or reduce its financial assets. They are non-recurring. Examples include Borrowings (domestic and foreign), Recovery of Loans, and Disinvestment proceeds from selling PSU shares.
- Expenditure: This refers to government spending. It is classified into:
  1. Revenue Expenditure: This is expenditure incurred for the normal running of government departments and various services. It does not create any physical or financial assets. Examples include payment of salaries and pensions, subsidies, interest payments on debt, and defence services expenditure.
  2. Capital Expenditure: This is expenditure that leads to the creation of physical or financial assets or a reduction in financial liabilities. It is long-term and development-oriented. Examples include spending on the construction of roads, bridges, hospitals, schools, and purchasing machinery, as well as the repayment of loan principals.

Prelims Pointers

Goods and Services Tax (GST) was implemented on July 1, 2017.
GST was introduced via the 101st Constitutional Amendment Act, 2016.
The GST Council is a constitutional body established under Article 279A.
GST is a destination-based consumption tax, replacing the earlier origin-based tax system.
Key items outside GST: Petroleum products (petrol, diesel, ATF), Alcohol for human consumption, and Electricity.
GST Compensation Cess was levied to compensate states for revenue loss for 5 years (July 2017 - June 2022).
The levy of GST Compensation Cess has been extended till March 31, 2026, to repay loans taken during the pandemic.
The E-Way Bill is mandatory for the movement of goods exceeding ₹50,000 in value.
Direct Tax: The impact and incidence of the tax fall on the same person.
The primary law for direct taxes is the Income Tax Act, 1961.
Minimum Alternate Tax (MAT) is levied at 15% on the ‘book profits’ of a company.
Dividend Distribution Tax (DDT) was abolished in the Union Budget 2020.
Wealth Tax was abolished in the Union Budget 2015.
Estate Duty (Inheritance Tax) was in effect from 1953 to 1985.
The ‘Annual Financial Statement’ is mentioned in Article 112 of the Indian Constitution.
Revenue Receipts do not create liabilities or reduce assets (e.g., tax revenue).
Capital Receipts create a liability or reduce an asset (e.g., borrowings, disinvestment).
Revenue Expenditure is for day-to-day functioning and does not create assets (e.g., salaries, subsidies).
Capital Expenditure creates assets or reduces liabilities (e.g., infrastructure construction).
The holding period for an asset to be considered a ‘Long-Term Capital Asset’ is:
1. More than 12 months for listed securities.
2. More than 24 months for immovable property.
3. More than 36 months for other assets.

Mains Insights

GST: A Test for Cooperative Federalism

Cause-Effect Relationship: The shift from an origin-based to a destination-based tax system (cause) necessitated a mechanism to address the revenue fears of manufacturing states, leading to the GST Compensation guarantee (effect). This constitutional guarantee was crucial for building political consensus for the reform. However, delays in compensation payment during the COVID-19 crisis strained Centre-State relations, highlighting the fragility of this fiscal federalism model.
Debate/Viewpoint: The GST Council is often cited as a stellar example of cooperative federalism. However, critics argue that the voting structure (Centre: 1/3rd, States: 2/3rd, with a 3/4th majority needed for decisions) gives the Centre a de facto veto. This raises questions about the balance of power and the erosion of states’ fiscal autonomy, as they have surrendered most of their indirect taxation powers. The Supreme Court’s ruling in Union of India & Anr vs M/s Mohit Minerals Pvt. Ltd. (2022) reaffirmed that the GST Council’s recommendations are not binding on the Centre and states, reinforcing the idea of cooperative but not coercive federalism.

Direct Tax Reforms: Balancing Growth and Equity

Debate on Corporate Tax Cuts: The government’s reduction of corporate tax rates in 2019 was justified by the Laffer Curve principle—the idea that lower tax rates can stimulate investment, growth, and ultimately lead to higher tax revenues. This is a supply-side approach to boost economic activity and competitiveness. The counter-argument, often from a Keynesian or welfarist perspective, is that such cuts reduce the fiscal space available for social expenditure and may exacerbate inequality if the benefits are not passed on through higher wages or lower prices.
Historiographical Viewpoint on Wealth/Inheritance Tax: The abolition of Estate Duty (1985) and Wealth Tax (2015) reflects a policy shift towards simplifying the tax system and improving the ease of doing business. However, in the context of rising global and domestic inequality, as documented by economists like Thomas Piketty and the World Inequality Report, there is a growing debate about their reintroduction.
- Arguments for reintroduction: Promotes equity, reduces inter-generational wealth concentration, generates revenue for social sectors.
- Arguments against reintroduction: Past experience shows low yields and high administrative costs; could lead to capital flight and discourage wealth creation within the country.

Quality of Government Expenditure: A Key to Development

Analysis of Budget Structure: The distinction between Revenue Expenditure and Capital Expenditure is critical for analyzing the quality of public finance. A high proportion of Revenue Expenditure, especially on non-developmental items like interest payments and general administration, can be a sign of fiscal stress.
Cause-Effect Relationship: Higher Capital Expenditure (CapEx) has a greater multiplier effect on the economy. Government spending on infrastructure (a form of CapEx) creates assets, generates employment, crowds in private investment, and boosts long-term productive capacity. Conversely, a budget dominated by revenue expenditure, particularly on subsidies, can lead to a vicious cycle of borrowing, higher interest payments, and reduced funds for asset creation, hindering long-term growth. The government’s recent focus on increasing the share of CapEx in the budget is a strategic move to drive a post-pandemic economic recovery.

GS Notes