Author:
Publication: The True Picture
Date: March 17, 2018
URL:      https://www.thetruepicture.in/world-bank/

There has been a lot of commentary on the ‘India Development Update – India’s Growth Story’ released on March 14 by the World Bank. In particular, the commentary on GST has been highlighted by a section of the media and other commentators.

However, as happens in most such cases, media reports are mischievous, as they have picked up the conclusion paragraph only, ignoring many positive aspects of introduction and implementation of GST in India. Other commentators have latched on to one sentence in the report to suit their pre-determined narrative on GST and further their anti-GST agendas.

If we look in detail at the World Bank report and not merely cherry-pick as commentators seem to have done, we see that the report acknowledges and praises the whole spectrum of reforms introduced in recent years, such as the Bankruptcy Code. At the same time, its understanding of GST itself takes into account what is happening at the Centre and in states, how GST has been harmonising tax rates. The report even praises the GST Council as innovative and integrative. The conclusion of the report, which the media and commentators have chosen to solely highlight, too, actually mentions “teething troubles” as well as how these are being solved.

Thus, a detailed reading of the World Bank report points out the in-depth analysis of GST that has been done and the various positive aspects which have been highlighted. We present below various relevant extracts to help readers understand the World Bank report in a more holistic format as well as to correct the spin.

1. We argue that the deceleration to growth rates below 7 percent between Q3 2016–17 and Q2 2017–18 was an aberration, attributed to temporary disruptions in economic activity due to the twin policy events, as businesses prepared for implementation of the Goods and Services Tax (GST, an important indirect tax reform), and the economy adjusted to demonetization. At present, there are indications that the economy has bottomed out and, in the coming quarters, economic activity should revert to the trend growth rate of about 7.5 percent. (Page 9 – Executive Summary)
 
2. In addition, the states and the centre are playing an important collective role in the implementation of the reform agenda. There have been continuous efforts to improve the business environment, to ease inflows of foreign direct investment (FDI), and to improve the credit behaviour through the introduction and strengthening of an insolvency and bankruptcy framework. These reforms have been complemented by measures to widen access to financial services, promote digital payment systems, and the implementation of the historic GST code. The latter has harmonized the tax rates across states for goods and services, and has the potential to boost interstate trade, formalize the economy, and expand the tax base. (Page 9 – Executive Summary)

3. Maintaining the hard-won macroeconomic stability, a definite and durable solution to the banking sector issues, realization of the expected growth and fiscal dividend from the GST, and regaining the momentum on the unfinished structural reform agenda are other key components of attaining a growth rate of 8 percent or higher. As pointed out by the World Bank’s Systematic Country Diagnostic for India, a reform focus on moving to a more resource efficient growth path, making growth more inclusive, and enhancing the effectiveness of the Indian public sector can assure that these rates are sustained, moving more and more Indians into a status comparable to the global middle class. (Page 15 – Chapter I.1)

4. These reforms have been complemented by a new set of measures, including widening the access to financial services; promotion of digital payment systems; and implementation of the historic Goods and Services Tax (GST) code, which has harmonized the tax rates across states and goods and services, and has the potential to boost interstate trade, formalize the economy, and improve the tax base. (Page 43 – Chapter I.6)

5. RBI estimates that the GST will not have a significant impact on inflation since nearly 50 percent of the CPI basket is comprised of food items, which are taxed at 0 percent under the GST. Further, petrol and diesel are excluded from the GST. Hence the impact of GST on CPI inflation will depend on changes in tax rates of the remaining components of the CPI basket.

6. Merchandise exports grew at an average of 11.35 percent in Q1-Q2, 2017-18, maintaining their momentum from Q3-Q4 2016-17 despite reported disruptions caused by exporters adjusting to the new GST regime. Exports of petroleum, steel and iron, machinery and equipment were the main drivers of aggregate export growth. Merchandise imports grew at a faster pace of 22.15 percent over the same time period, driven by an increase in international commodity prices, and reflected in the faster imports of oil, gems and jewellery, and gold. (Page 71-72 – Chapter II)

7. Central government’s fiscal deficit has declined since 2011-12 and stabilized in 2017-18. Centre’s fiscal deficit declined steadily from an average of 5.7 percent of GDP during 2008-09 to 2012-13 to 3.8 percent in 2015-16; and further to 3.5 percent in 2016-17 due to the rationalization of subsidies and increase in indirect tax collections. (Page 79 – Chapter II)

8. Going forward, as implementation of the recently introduced indirect Goods and Services Tax and the bankruptcy law progress, India has the potential to improve its ranking further. The government has also taken steps towards emphasizing the quality over the quantity of reforms implemented in states’ Reform Action Plans. In addition, India has placed a strong focus on promoting knowledge sharing between states and on helping lagging states improve on their reform implementation. (Page 105 – Chapter III.A)

9. The Goods and Services Tax (GST) was introduced in India on 1st July, 2017, after more than a decade of efforts. It replaced an existing system of fragmented and complex indirect taxes, consisting of multiple central and state taxes. Under the earlier tax system, states unilaterally levied ‘entry taxes’ on all goods that entered its territory, resulting in inefficiencies and huge costs to the economy. The new GST was designed to bring about a common policy and administrative framework for taxation of the supply of goods and services across the entire country while causing minimum tax-based restrictions on trade, besides harmonizing the rates on goods and services. This note provides a brief description of the GST and benchmarks it against other countries. (Page 107 – Chapter III.B)

10. Any tax on value added in a federal system of government with overlapping taxing powers is challenging, as taxing powers must be clearly defined and tax rates should be as uniform as possible across the country. (Page 107 – Chapter III.B)

11. The administration of GST has been harmonized between the centre and the states using a common IT system and common rules with the powers to audit being shared. To support the administration of the taxpayers, a common nation-wide IT backbone called the GST Network (GSTN) has been put in place, through which all tax returns are required to be filed. This portal captures all tax returns and allows for verifying input tax credits claimed by businesses. The system can also aid in the selection of taxpayers for audit through a risk-based selection mechanism. (Page 108 – Chapter III.B)

12. On the policy side, coordination between the Centre and the States and, between States is made possible through a GST council comprising of the finance ministers of all the State governments and the Central government. The GST council is an innovative and integrative body that formulates a common policy and administrative framework for the GST that applies to the entire country. (Page 108 – Chapter III.B)

13. The introduction of the GST to replace state level value added taxes was motivated by an attempt to harmonize indirect taxation across India, therefore eliminating state level barriers to trade and broadening the tax base. The challenge with designing any tax system is that most forms of taxation may reduce the private sector’s incentives to save or to invest. In addition to the direct burden of taxation, taxpayers are also affected by the cost of complying with tax obligations, for example through effort required to file tax returns. Taking these considerations into account, the design of the Indian GST system was guided by the objective to raise revenue while minimizing the burden of taxation on consumers and producers and limiting the cost of compliance to businesses. In practice, the fitment committee, tasked with selecting GST rates, approximated rates for a certain good or service to the most prevailing total rate including excise and state VAT and other levies. This procedure meant that the feature of traditional indirect taxes in India, which protected the consumption basket of the poor, has been maintained in the GST. (Page 108 – Chapter III.B)

14. The number of different tax rates also determines the complexity of the GST, with multiple rates imposing additional costs on compliance for businesses as well as the tax administration and encouraging evasion. Second, the registration threshold determines which taxpayers are covered by the system. This is thus an instrument that governments can use to relieve smaller firms from the burden of complying with a GST. As is the case in India, it is also possible to introduce a simplified system in lieu of exemptions for smaller firms which is administratively easier. The disadvantage of introducing registration thresholds and having a simplified and presumptive tax regime is that it inevitably fragments the tax system, which may reduce the tax base and provide an incentive for larger firms to mask their size and benefit from the reduced compliance burden. In addition, tax schemes that levy taxes on sales rather than value added provide incentives for sellers to reduce their taxable sales, and potentially promoting economic inefficiencies by dis-incentivizing business growth, integration and expansion. Taken together, this discussion suggests that the design of a GST systems faces trade-offs between revenue collection, protecting the poor and reducing the taxation and compliance burden on firms and consumers. The way that the design parameters are set is ultimately a policy decision that depends on the objectives of the government. The next section compares the design of the Indian system with international practices, keeping in mind that the introduction of a new tax system is the start of a process of reforms rather than the end and will require strong accompanying measures with continuous adjustments and improvements during implementation. (Page 108-109 – Chapter III.B)

15. In addition to the number of rates, the extent of exemptions and sales at a zero rate is a critical design parameter for a GST. While exemptions allow to ease the tax burden on items with a high social value, such as healthcare, they also reduce the tax base and compromise the logic of the GST as they can: reintroduce cascading where an exempted good or service is an input into another taxable good or service; create incentives for vertical integration to keep the exempt status; and raise compliance costs by making it necessary to allocate input taxes between exempt and non-exempt output when manufactured or traded together. In contrast to other GST design parameters, comparing the prevalence of exemptions across countries is challenging. This is because the impact of declaring various goods as zero-rated does not only depend on the number of products exempt, but also on the revenue generated from each product. The latter figure is difficult to assess in the absence of tax revenue figures. Hence an assessment of the role of exemptions in the Indian GST system cannot be made before revenue figures have stabilized. The threshold to register for the GST is another important policy parameter. In India, businesses having annual sales above the threshold of INR 15 million fall under the full GST, and are thus liable to remit GST and eligible to deduct input tax credit. Those with annual sales above the lower threshold of INR 2 million and below 15 million are required to register for the GST and pay a ‘flat’ 1 percent tax on sales, but are neither allowed to charge GST on sales nor deduct any taxes on inputs. Comparing India internationally, Figure 63 shows the upper GST threshold for a sample of 31 countries compiled by the European Commission, which includes all the EU countries and China and Malaysia. India started with a higher threshold of $116,000 (7.5 million rupees) but in the span of a few months doubled it to $232,000 (15 million rupees) mainly to ease the cost of compliance for SMEs. India’s new threshold is the highest among all the 31 comparator countries. The lower threshold of INR 2 million ($30,770) is in line with most countries in the EU. In contrast to the EU, however, the registration threshold in the EU applies to the full GST, unlike in the case of India where the lower threshold implies participation in the “composition scheme”. Such schemes for SMEs under the GST also exist in other countries, where businesses below a certain threshold pay a (lower) ‘flat’ turnover tax and are not allowed to collect tax as well as claim input tax credits. China and Poland use a similar ‘flat’ rate scheme. In other simplified schemes, businesses collect taxes on sales just like other registered GST business but can pay the tax as a ‘flat’ percentage of sales but the input credit is ‘deemed’ as a fixed percentage of sales. Such countries include the UK, Canada, Austria and Belgium. (Page 111-112 – Chapter III.B)

16. To address these challenges, the GST council has begun a process of lowering and consolidating tax rates. In August 2017, the council lowered the tax rate for job work along the textile sector value chain to 5 percent from 18 percent. In September 2017, the GST rate on about 30 commonly used products was lowered, and this process was extended to another 27 goods in October 2017. On the administrative side, the GST council recommended faster processing and payments of refund claims. To ease the compliance burden for small and medium businesses the council changed the filing frequency from monthly to quarterly for firms with annual aggregate turnover up to INR 15 million. The council also increased the turnover limit for the “composition scheme” from INR 7.5 million to INR 15 million. In addition to procedural amendments, the council is also considering technological improvements to facilitate GST administration. As such, the GST council announced the introduction of an “e-wallet” scheme by April 1st, 2018. Under this scheme, advance refund payments will be credited to a virtual account, which can be used to make GST related payments. In addition, early 2018 is expected to see the wider introduction of the “e-way bill system”, which facilitates a technology-driven tracking of movement of goods worth more than INR 50,000 and for sale beyond 10 km in distance. Despite the initial hiccups, the introduction of the GST is having a far-reaching impact on reducing tax related barriers to trade barriers which was one of the primary goals of the introduction. Logistics companies are reporting that trucks now cover an additional 100-150 km per day after GST an increase of up to 30 percent. Logistics companies are also consolidating their existing fragmented set of small warehouses in each state, now that the GST has removed state imposed barriers thereby increasing their efficiency. However, the introduction of the “e-way bill” may result in some fresh barriers to the free movement of goods in the form of road inspections to verify the goods being transported. (Page 112-113 – Chapter III.B)

Finally, this is how the World Bank concludes its analysis of GST implementation:

Conclusion