By Ronak Pol
On August 3, 2016, a historic landmark was achieved in the Indian Politics, when the Goods and Services Tax (GST) Bill was passed unanimously. An oversimplification implies that with the introduction of GST, some goods will become cheaper, while services might become expensive. The media has frenziedly covered how it will change things for the Indian consumers. But this article explores the less talked about inference: GST’s effect on the government budget.
It doesn’t take an economist to conclude that tax revenue is a major part of the government’s income which is then used for budgetary spending. Depending upon the difference between government income and government expenditure, we get either a budget deficit or a budget surplus.
The Basics of GST
By introducing a unified tax rate, it will change the way we pay our indirect taxes. It does away with all indirect taxes and brings in a single tax collected by the Central Government.
GST will in no way alter direct taxes like income tax.
To answer how GST affects Governments (Central/State/Local bodies), we need to understand different taxes and their collectors. Out of the many indirect taxes, this article focusses mainly on the major ones.
- Manufacturer – Wholesaler
Suppose you produce a good X in Pune, and its manufacturing cost is $100. When you send this good to your wholesaler for $120, you have to pay two taxes: Excise Duty (collected by Central Govt.) and VAT/CST (Value Added Tax/Central Sales Tax collected by the State/Central Govt). Some goods come under state excise jurisdiction while CST is paid when goods are sold outside the State boundaries. Here, we are excluding good X from these categories. Therefore:
- Tax Collected pre-GST = $15 Excise Duty (12.5% on 120$) paid to the Centre
$15 VAT (12.5% on 120$) paid to the State
Tax collected post-GST = $21.6 GST (18% on 120$) paid to the Centre
- Wholesaler – Retailer
Once the wholesaler receives the goods, he will add his margin and send it to the retailer at a price of say $150. In this scenario too, two taxes come into play: VAT and Octroi (collected by The Local Municipal Corporation). VAT is paid not on the profit margin added by the wholesaler, but on the entire amount. Down the supply chain, individuals receive input credit for the amount of VAT paid. But for ease of explaining, we show the net VAT paid.
- Tax Collected pre-GST = $3.75 VAT (12.5% on 30$) to the State.
$6 Octroi (4% on 150$) to the Municipal Bodies
Tax collected post-GST = $5.4 GST (18% on 30$) by the Centre
- Retailer – Consumer
If the goods are ultimately sold for $200 each, tax collection takes place as follows:
Tax Collected pre-GST = $6.25 VAT (12.5% on 50$) by the State.
Tax collected post-GST = $9 GST (18% on 50$) by the Centre.
- Total Tax under the regular system comes out to be $46. Under GST, the same figure falls to $36.
Hence, in this case, GST has reduced the government’s revenue by a significant 21.73%. Although this is a very simplistic example and does not cover the entire spectrum of goods, it does highlight the issue of a decrease in government’s income.
Another striking feature is that Municipal corporations will face significant losses of revenue. For Corporations like BMC, octroi collection accounts for over 20% tax receipt and stands at 6,850 crores.
A Pseudo Investment?
GST reduces administration cost significantly. In the current system, we have various mutually exclusive departments that do not share resources or information. Bringing in GST will help administrators in merging their resources, forming a more efficient tax collection body, and bringing clarity and ease in the way tax is paid and collected. The government hopes that these two put together, will improve collection rates and in the long run compensate for the loss of revenue.
A reduction in government jobs is almost certain, but we can safely say that the current regime of employees will only be reassigned, not laid off. The issue of loss of revenue for municipal bodies still remains and the central government will have to work with the States to come up with a plan for fair distribution of tax collection so as to not damage local budgets.
What the Future Holds
Once ratified by the States and signed by the President, GST still has a long way to go to be accepted by Indians. It is definitely a progressive step and holds tremendous potential. On the other hand, it might damage government budget. Consumer acceptance of the law is still questioned but the current scenario paints a positive picture.
Once passed, GST will be a political victory for the Government. But will it be implemented properly and become a feather in BJP’s political cap? Only time will tell.
Ronak Pol is a student of Economics and Finance at University of London International Programmes and currently works as an editor with the blog EconPolitics.