Any tax system is finally a statement of morality. The greater the tax evasion in an economy, the lower the morality, the higher the tax claws of the state, the higher the walls for honest entrepreneurs. Flowing from it all are minor devil-containing details like rates and procedures of the tax system, and the related burden of compliances on taxpayers. The recently passed Goods and Services Tax (GST) law and the ongoing discussions on rates, procedures, dates of implementation, and the administrative jurisdictions of collecting taxes between the Centre and the States, is as much an economic conversation as a moral one.
If the findings of Reserve Bank of India’s report, State Finances: A Study of Budgets of 2016-17, are any indicator, apart from bringing efficiency into the tax administration, the GST Council, that’s having this conversation in Srinagar on Thursday (18 May), will have to, among several other issues, deal with tax avoidance. This is not specific to India. “International experience points out some likely risk relating to tax evasion and avoidance,” the report warns in a chapter entirely devoted to GST. These are:
- Non-registration by small businesses,
- Under-reporting by traders,
- Reduction of tax liability by exaggerating the proportion of taxes in lower slabs,
- Collecting but not remitting tax to the government, and
- Making false claims for refunds.
Although governments are more concerned about their finances than entrepreneurs’, it seems that inadequate attention has been paid to the latter. So, while the GST can arguably be said to be the single most important tax reform — and politically the most intense, given the unity of political parties at the Centre and the States that needed to bring it on board — there are doubts about whether the efficiency that was planned and drafted will bear fruit when it is implemented.
The Srinagar conversations need to ensure that the pass-through nature of GST is frictionless. While compliance by taxpayers is key, the process need not be oppressive. In the case of GST, it’s even easier — the tax is a pass-through, that is the entrepreneur merely needs to price the tax into his product and get going. Nobody likes to pay taxes. But the GST is not going out of the pocket of entrepreneur, she is merely the conduit for its final destination — to provide welfare to the citizens at large through contribution to the country’s public finances. As a result, the burden of morality is lighter than say in direct taxes. And so, the GST Council must ensure that the processes and procedures facilitate rather than intimidate entrepreneurs.
Under the new law, the micro and small sector will meet the might of compliance for the first time. From excise duty exemptions of ₹1.5 crore, the registration threshold under GST has been brought down to ₹50 lakh, which is a good thing — as the Indian economy grows, so must its taxpayers. So, the compliance requirements for them will multiply. But it is services where GST will stretch its tentacles, when the “benevolence of centralised registration would be taken away,” write Shashank A. Kumar and Meghna Mohapatra. “The number of filings would increase from two to 37 in a year for each registration.”
While large corporations will be able to shift with ease, the entirely digital tax infrastructure would intimidate small taxpayers with its processes, costs and digital illiteracy. They will need to upload and download invoice data, supplies, match their purchases and so on for every transaction. Even if the entire process is automated, and despite the best of intentions, the process will leave enough of room for errors, a legacy of the past that created lavish pipelines to bribery. There is an implicit assumption of a base level automation at the taxpayers’ end, which may not match the on-ground reality.
While large corporations will be able to shift with ease, the entirely digital tax infrastructure would intimidate small taxpayers with its processes, costs and digital illiteracy.
The government seems to have thought through this problem through the creation of GST Suvidha Providers (GSP), an ecosystem that provides solutions to make tax filing easy. “In GST system all taxpayers have to provide details of all invoices along with all line items in a particular format for various returns,” the Goods and Services Tax Network states. “This mandate will require some sort of automation at all taxpayers [sic] end. Of course, already automated systems have to be tweaked to comply with this mandate. So it is a big opportunity for GSPs.”
Any system that has built-in opportunities for intermediaries is flawed in its policy design and, in the case of GST, may not work out for entrepreneurs. Unless the Srinagar conversations change it, the GST is in the process of building a flood of prospects for not only GSPs, but chartered accountants in the pre-transition and first few years of transition, and for lawyers once claims start to get contested in courts. Additionally, the implementation of the GST could place the burden of compliance on firms themselves, as Saral Mukherjee and Bharat Goenka argue, turning business enterprises into financial Big Brothers. This is bad news for doing business.
But let us not go overboard. When we observe firms as entities run by individuals, and individuals who run on habits, any policy that brings change is seen as an inconvenience multiplied. The GST is a disruption, a major disorder in a system that for good or bad has been flowing and has reach an equilibrium. To shift into this disruptive system, howsoever efficient it be, will not be an easy task. At the level of the government, a lot needs to be done in Srinagar. While the focus would likely be on macroeconomics and the Centre-States tussle of rates and their jurisdiction, the complexity of compliance must not be ignored.
Among the criterion for good taxation, Adam Smith considered equality, certainty, convenience of payment, and economy in collection as most important. Of these tenets, the rates of GST that Srinagar is expected to finalise will determine equality and certainty — unconfirmed reports suggest a four-slab structure of 5%, 12%, 18% and 28% for 90% of goods and services. The economy of collection will remain a tug-of-war between the Centre and the states. But the burden of convenience of payment will fall on the entrepreneur. The GST has been envisioned as a facilitator, its execution must mirror that ideal. But more than that, it must be seen to be a catalyst for economic growth through a partnership with firms.
Among the criterion for good taxation, Adam Smith considered equality, certainty, convenience of payment, and economy in collection as most important.
Already, the lofty numbers the GST was expected to deliver are being toned down. The RBI hints that the expected increase in GDP growth rate may be around to 0.7 percentage points, as the experience of advanced economies that made this shift has shown. This is significantly lower than what was estimated eight years ago. “Preliminary results [of a study commissioned by The Finance Commission and executed by NCAER] indicate that the growth in GDP can be between 2-2.5% with the implementation of a well-designed GST,” then chairman of the 13th Finance Commission Vijay Kelkar had told the National Executive of FICCI (Federation of Indian Chamber of Commerce and Industry) in an October 2009 speech. Informal discussions with experts in firms and government indicate that the first two quarters of GST implementation may even lead to a contraction in output and sales, and may show itself in weak GDP numbers.
All these macro numbers of GDP growth, tax-GDP ratio or administrative jurisdictions have one source: the firm. And if the cost of compliance rises disproportionately, the propensity to evade taxes rises; if the inconvenience of complying jumps, so does the bypassing of the tax system itself. For large corporations, the expected tripling of compliance costs is statistically insignificant in their total expenditures, though the fall in sales and profits will hurt. But it is the small and medium enterprises that will bear the brunt of compliance in the goods sector, while the services sector will face the fire.
At stake is one indicator that the three-year-old Modi government has been lagging in — job creation. By looking at GST execution as a cog in the larger ease-of-doing-business wheel, governments can reshape not merely the economic efficiency of India but the morals of businesses. The digital infrastructure on which GST stands is robust enough to capture the evaders and plug their escape routes. But the quest for evaders must not penalise the entire system. Simplicity of processes, unambiguity of rates, and a little handholding is all that entrepreneurs need from the GST. The Srinagar conversations must ensure that the process of GST does not become larger than the purpose of GST.
The views expressed above belong to the author(s).