A Thriving Tax

JUST AHEAD OF THE 2019 General Election, the familiar pulls and pushes of electoral politics were at play. The Union finance ministry was besieged with requests, growing more insistent by the day, to reduce tax rates on various products. A particularly vocal demand came from the automobile sector that wanted the 28 per cent slab for cars to be reconsidered, arguing that cesses and other levies meant that the actual burden was much higher. The government was reluctant to give in to the demands as it was felt that succumbing to one sector would only encourage others. Prime Minister Narendra Modi remained sceptical of the benefits of the rate cuts and his record as chief minister of Gujarat and later at the Centre suggested that he was not very keen on pre-poll ‘gifts’ like free power pledges or rate cuts like the one demanded. The finance ministry, though, did have an idea. Why not offer a low 5 per cent rate for electric cars? This would encourage production of low-pollution vehicles and develop a new technology too.

When then Finance Minister Arun Jaitley had asked then Revenue Secretary Ajay Bhushan Pandey what the costs of such a proposal would be, the answer surprised as well as pleased him. As there was no current production of electric cars in India on any significant scale, the ‘loss’ of revenue was zero. When the proposal was presented to the Goods and Services Tax (GST) Council, it won wide support. Delhi Finance Minister Manish Sisodia did point out that there would indeed be revenue implications when production began but the council felt that the rates could be re-jigged if needed at that point in time. The new tax rate found a pride of place in the 2019 Budget presented in July by Union Finance Minister Nirmala Sitharaman and by 2021 a new range of electric cars began to hit the market. India’s share of the global electric vehicles (EV) market crossed 8 per cent in 2021, more than double of what it was in 2020. The growth of two wheelers and four-wheel ‘rickshaws’ has been phenomenal. “It was a decision that appeared not so consequential but has had a very significant impact. India’s EV manufacturing is thriving and pricing is more competitive than it is in many other countries,” Pandey, who retired from government in 2021 and currently heads the National Financial Reporting Authority, told Open. The decision meant that India more or less gave up the idea of pursuing hybrid vehicles, something that caused some consternation among Japanese automakers like Toyota that had been assiduously pushing for concessions. But the advantage was that Indian industry was able to leapfrog into a newer sector.

As India clocked five years of GST, the functioning of the ‘one nation, one tax’ system has several such milestones to relate that reflect a robust collaborative decision-making by the Centre and the states, amid frequent political skirmishes over ‘eroding’ federalism. The GST Council has seen sharp differences being articulated, with state finance ministers like West Bengal’s Amit Mitra and Kerala’s Isaac Thomas (both former ministers now) sharply outlining their differences with the Centre. But, as officials and politicians who have attended the meetings of the council point out, none held up or opposed key reforms like rationalisation of slabs, adoption of the “one-way” return filing system, e-invoice and invoice matching. A consensus on extension or termination of the compensation scheme for states (guaranteeing a 14 per cent revenue increase) was not expected and some experts contend that the matter is beyond the mandate of the GST Council.

Having survived initial uncertainties and then the Covid shock, the GST system is a testimony to federalism in practice. While Covid has brought home the importance of collective thinking and action, it has also encouraged states to move from a political focus that always sought a reduction of rates

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The minutes of the council are recorded verbatim and are available on the council website. They largely reflect the consensual nature of the council’s functioning under the late Jaitley and later under his successor Sitharaman. The discussions are thorough and detailed, reflecting a high order of expertise as state finance ministers, state and Central officials, and the Centre confer with each other.

Having survived initial uncertainties and then the Covid shock, the GST system, where both Centre and states gave up some of their taxation powers, is a testimony to federalism in practice rather than a mechanism that allows the Centre to impose a ‘big brother’ viewpoint on others. Interestingly, while Covid has dramatically brought home the importance of collective thinking and action, it has also encouraged states to move from a political focus that always sought a reduction of rates.

One interesting case involved the issue of taxation of puja samagri (prayer materials). On an earlier occasion, Uttar Pradesh regularly brought to the council a demand for reducing tax on puja samagri to zero and finally succeeded in its quest. Something similar was at play in the case of agarbatti (incense sticks) that was originally taxed at 12 per cent but the rate was later reduced to 5 per cent, winning the council plaudits from Karnataka. Agarbatti is a major economic driver in many states and of their local economies both in terms of production and sales. Thus, a higher tax slab on the item did not go down well with many states. The sharp drop in revenues in 2020 and the Centre’s firm stance that the revenue compensation would end in June 2022 have prompted states to reconsider their assumptions. In the five years since GST came into existence, the council has had to take recourse to a vote only once when deciding the rate for lotteries. Kerala insisted on a two-rate system which the Centre thought might lead to manipulation by operators. Even in this case, the council waited almost a year, hoping that an agreement could be reached.

Given that GST was proposed as early as 2006 by the United Progressive Alliance (UPA) government and a working draft was available by 2010, it is surprising that it took until June 2017 for it to be rolled out. After the Modi government assumed office in 2014, it moved the bill in the winter session. But after that a bizarre political blockading by a section of the opposition led by Congress in Rajya Sabha, where the new government had lacked numbers, stalled progress. Congress leader Rahul Gandhi demanded that a cap of 18 per cent be written into the legislation, deletion of a provision for 1 per cent additional levy, and an independent dispute-solving mechanism. These were clear deal-breakers. As the numerous changes in the rates demonstrated, setting an 18 per cent rate in the law would have rendered the tax dysfunctional. It would have meant that Parliament would have had to amend the law every time a rate was altered. As the government pointed out, GST was replacing a medley of taxes like excise, VAT, Octroi and customs, and slabs were not only inevitable, they might need frequent change. Egged on by Left leaders like Sitaram Yechury and some others, Rahul Gandhi had led the way in holding back GST for two years before Congress leaders began to point out that the perception that the party was preventing reforms was hurting it. Meanwhile, a Rajya Sabha select committee under BJP leader Bhupendra Yadav also examined the bill and submitted a report where most members agreed on the law’s more substantial elements. It was no surprise when Congress boycotted the midnight event in Parliament’s Central Hall to launch the law. While Congress referred to the government’s silence on “attacks on minorities” as a reason for staying away, the real reason seemed to be a peeve about the midnight session in the Central Hall, an occurrence associated with Jawaharlal Nehru’s Independence Day address in 1947. Congress said there had been other such events only on the silver and golden jubilees of Independence.

These obstacles would have proved insurmountable had it not been for the backing of Prime Minister Modi and the persuasive powers of Arun Jaitley, who was finance minister during a very critical period, before an agreement was reached between the Centre and the states, Bihar’s former Deputy Chief Minister Sushil Modi told Open. Sushil Modi was chairman of the Empowered Committee of State Finance Ministers for the Implementation of GST.

The success of the GST system lies in its ability to provide real-time information on revenues and, therefore, the health of the economy. It is now routine for GST collections to exceed ₹ 1.4 lakh crore every month. In June, this figure was ₹ 1.44 lakh, representing a 56 per cent increase in the tax on a year-on-year basis. At one time, any collection above ₹ 1 lakh crore in a month was celebrated. Now that is routine. Another indicator of the success of the tax is in terms of e-waybills generated in the GST system. In fiscal 2021-22, 77.4 crore e-waybills were generated, a steady climb from the 55.8 crore in 2018-19, a year after the tax was introduced. Even in 2020-21, a difficult pandemic year, this number stood at a healthy 61.7 crore.

The reasons why the council has worked well are in all the hard work that preceded a meeting. Two committees—the law and fitment panels—meet often to discuss proposals and carry out detailed economic analysis. The fitment committee goes into which rate would be applied to a product under the GST regime. This often meant a decision on whether the rate would be higher or lower than what was applicable prior to GST. Sometimes, the tax slab went up but officials explained that this might still be preferable to the cascading taxes under the previous system which actually resulted in rates as high as 25-30 per cent. Once the fitment committee completes its work, the proposals are examined by the law committee that considers if rules under various laws or the laws themselves need changes. Thereafter, ahead of a meeting of the council, proposals are put before a committee of officials from all states and the Centre. This allows states not closely involved with a particular matter to familiarise themselves with the discussions. The pre-council meeting serves another useful purpose: it gives state officials a fair idea of the support a viewpoint advocated by their state enjoys. Often, officials report to their political principals that a proposal might not make it past the council or its prospects might improve if amended.

The revenue expansion is the result of a growing economy as much as a function of more businesses filing their returns. Bankers say that it has become easier to provide to small and medium enterprises as much more credible information is available on their tax, credit and transaction histories

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The rates on various goods often lead to bickering in public that makes it appear that proceedings in the GST Council are adversarial in nature. But this is a mistaken belief. Take the latest rate decision of the council to levy a 5 per cent tax on paneer, lassi and some other food items. This has led to a furore in the opening days of the monsoon session of Parliament. But it is another matter that there was not a whimper of protest when the decision was taken in the council. At least at that time no political party opposed to the ruling coalition said anything. What happens behind the closed doors of the GST Council is consensual decision-making.

Getting the technical aspects of the GST system to work smoothly was a challenging task. The Union finance ministry was well aware of the possibility of evasion through devices like false invoices or “layering” or a method of moving transactions through several front companies to show that most of the value addition has already happened. The filing system did need considerable tweaking and former Infosys whiz Nandan Nilekani was brought in to help sort out the problems. His interventions in early 2020 were to prove crucial for things to fall in place. Nilekani advised that there had to be a “matching” of invoices between the sellers and the receivers at all stages. He strongly opposed two separate sets of data being filed and said there should be a “one-way system”. “What Nilekani said was an application of how emails work: If I send an email to you, then you will certainly receive it. So an invoice filed by a particular seller must simultaneously ‘sit’ in the account of the supplier. This means both must account for the invoice, otherwise the input credit cannot be claimed,” said Pandey.

As the new regime struck roots, the algorithms used by the tax department grew more and more sophisticated, and gaming of the system became more difficult. Moreover, frauds were prosecuted and jail time became a significant disincentive for would-be cheats. Officials familiar with GST point out that it did not develop in isolation and that it was accompanied by other reforms that considerably corrected the information asymmetry that handicapped tax authorities. The linking of Pan-Aadhaar-bank and active sharing of information from customs and income tax through IT network accounts helped reduce dummy operations. In the past, an individual or a firm could have got away by providing differing information to various agencies, counting on them to not exchange notes. That is no longer possible and a 360-degree profiling is just that—a complete financial picture. All major transactions, such as purchase and sale of stocks, property, investments and interest earned can be tracked and matched with filings.

On the politically contentious issue of the compensation regime, it is pointed out that data from 2015-16, before GST was implemented, showed that the Centre and states totalled about ₹ 85,000 crore of revenues a month. This has now gone up to ₹ 1.20 lakh crore on an average. If Covid is seen as a truly black swan event, it is clear that the revenues are much higher than would be considered feasible earlier. Without GST, a growth of 20 per cent would be seen as a success while now the revenues have shot up. “The logic behind the compensation was to assure states that their revenues will not suffer. But this fear is no longer justified given the manner in which revenues have risen. The idea is that taxation must be fair and balanced. After all, the cess collected for compensation comes from citizens,” argues Pandey.

The discussion has taken a political turn with some states like Tamil Nadu and West Bengal regularly claiming that compensation due has not been received. The Centre has responded that a claim due at the end of a certain period cannot be considered outstanding. In any event, the Centre has not extended the compensation period as it was felt that the 42 per cent devolution to states has come at its cost. The revenue expansion is the result of a growing economy as much as a function of more businesses filing their returns. Bankers say that it has become easier to provide to small and medium enterprises as much more credible information is available on their tax, credit and transaction histories. The risk for banks has declined and this is helping them finance businesses and individuals. The digitalisation of the tax system has happened alongside the explosion in UPI payments and the widespread use of Aadhaar and mobile phones for processing transactions. The emergence of startups and the steady growth in unicorns is related to the boost provided by a modern tax system and the overall digitalisation of the economy, including the staggering rise of fintech and evidence of the doubling and tripling of retail investors in the stock market. Looking ahead, an area that will need attention is further reduction of the number of slabs, never an easy task.

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Rajeev Deshpande

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Siddharth Singh

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