Dated:- 10-12-2015 – I. INTRODUCTION 1.1 As the world economy slows, and increasing financial volatility and turbulence become the newest normal, only a few economies have the resilience to be a refuge of stability and the potential to be an outpost of opportunity. India is one of those few. As oil and commodity prices continue to be soft, and in the wake of actions taken by the government and the Reserve Bank of India, macro-economic stability seems reasonably assured for India. This bedrock of stability coupled with reforms to unleash the entrepreneurial energies of India can create the policy credibility and business environment that India is indeed seizing the historic opportunity afforded by domestic and international developments to propel the economy to a high growth trajectory. Key amongst these reforms is the goods and services tax (GST), which has, in some ways, been priced into expectations of the government s reform program. 1.2 For nearly ten years, India has been on the
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ems-European Union, Canada, Brazil, Indonesia, China and Australia-that have a VAT (the United States does not have a VAT). 1.4 As Table 1 highlights, most of them face serious challenges. They are either overly centralized, depriving the sub-federal levels of fiscal autonomy (Australia, Germany, and Austria); or where there is a dual structure, they are either administered independently reating too many differences in tax bases and rates that weaken compliance and make inter-state transactions difficult to tax (Brazil, Russia and Argentina); or administered with a modicum of coordination which minimizes these disadvantages (Canada and India today) but does not do away with them. Table 1: Comparison of Federal VAT Systems Nature of VAT Country Examples Disadvantages Independent VATs at Centre and States Brazil, Russia, Argentina Differences in base and rates weaken administration and compliance. Inter-state transactions difficult to manage. VAT levied and administered at Centre Austral
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sible additional excise taxes on sin goods (petroleum and tobacco for the Centre, petroleum and alcohol for the States)-will provide the requisite fiscal autonomy to the States. Indeed, even if they are brought within the scope of the GST, the states will retain autonomy in being able to levy top-up taxes on these sin/demerit goods. 1.6 Provided it can be reasonably well-designed, the Indian GST will be the 21st century standard for VAT in federal systems. 1.7 It is, therefore, imperative to ensure that the design and implementation of this policy is done right. And, one important, perhaps critical, dimension of this is the level and structure of tax rates on which this Committee has been asked to make recommendations. II.BENEFITS OF PROPOSED GST 2.1 Many benefits are claimed for the GST: that it will increase growth1; that it will increase investment by making it easier to take advantage of input tax credits for capital goods; and that it will reduce cascading.2 While these are import
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n through wide ranging exemptions, especially on intermediate goods, this self-policing feature can work very powerfully in the GST. 2.4 According to Pomeranz (2013), The Value Added Tax (VAT) is a stark example of a tax believed to facilitate enforcement through a built-in incentive structure that generates a third party reported paper trail on transactions between firms, which makes it harder to hide the transaction from the government (e.g. Tait, 1972; Burgess and Stern, 1993; Agha and Haughton, 1996; Kopczuk and Slemrod, 2006). This belief has contributed to one of the most significant developments in tax policy of recent decades (Keen and Lockwood, 2010): a striking increase in VAT adoption from 47 countries in 1990 to over 140 today (Bird and Gendron, 2007). 2.5 The best evidence of the impact of the paper trail on evasion comes from an experiment in Chile which shows that firms that are part of the VAT chain are less responsive (in terms of evasion) to announcements of an increa
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favouring imports and disfavouring domestic production. The GST would rectify it not by increasing protection but by eliminating the negative protection favouring imports and disfavouring domestic manufacturing. 2.8 These distortions are caused by three features of the current system: the central sales tax (CST) on inter-state sales of goods; other numerous inter-state taxes that will be replaced by the (one) GST; and the extensive nature of countervailing duty (CVD) exemptions. CST3 2.9 The 2 per cent CST on inter-state sales of goods leads to inefficiencies in supply chain of goods. Goods produced locally within the jurisdiction of consumption attract lower tax than those produced outside. This tax encourages geographic fragmentation of production. The tax can be avoided partially through branch/stock transfers by manufacturers. However, the tax savings from branch transfers get substantially offset by the incremental costs of logistics and warehousing of goods in multiple locations
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e a number of inter-state taxes that are levied by the States in addition to the CST. These include: entry tax not in lieu of octroi and entry tax in lieu of octroi. 2.13 Under the GST, all these taxes would be folded into the GST with enormous benefits. What are the benefits? 2.14 There is ample evidence to suggest that logistical costs within India are high. One study suggests that, for example, in one day, trucks in India drive just one-third of the distance of trucks in the US (280 kms vs 800 kms). This raises direct costs (wages to drivers, passed on to firms), indirect costs (firms keeping larger inventory), and location choices (locating closer to suppliers/customers instead of lowest-cost location in terms of wages, rent, etc.). Further, only about 40 per cent of the total travel time is spent driving, check points and other official stoppages take up almost one-quarter of total travel time. Eliminating check point delays could keep trucks moving almost 6 hours more per day, eq
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high (about 72 per cent) and much higher than in comparable countries and rising over time because of under-investment in the Railways (Economic Survey, 2015, pp.92-94). The implication is that it is especially important for India to reduce costs to inter-state trade because of the excessive reliance on roads for movement of goods. 2.17 Now, all of these costs are not due to taxes. But, the World Bank estimates that about 20-30 per cent are (World Bank).6 It is these costs that can be expected to decline with the introduction of the GST, providing a boost to inter-state trade and hence productivity growth within India.7 CVD and SAD Exemptions 2.18 It is insufficiently appreciated that India s border tax arrangements undermine Indian manufacturing and the Make in India initiative. Eliminating exemptions in the countervailing duties (CVD) and special additional duties (SAD) levied on imports will address this problem. How so? 2.19 It is a well-accepted proposition in tax theory that achi
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out costs). But the important and subtle point relates to scenario 3 when the excise and CVD/SAD are both exempted. This may seem apparently neutral between domestic production and imports but it is not. The imported good enters the market without the CVD/SAD imposed on it; and, because it is zero-rated in the source country, is not burdened by any embedded input taxes on it. The corresponding domestic good does not face the excise duty, but since it has been exempted, the input tax credit cannot be claimed. The domestic good is thus less competitive vis-à-vis the foreign good because it bears input taxes which the foreign good does not. In the example, the penalty on domestic producers is over 6 per cent. In effect, a policy designed to promote domestic manufacturing through excise exemption creates a perverse incentive for the exempt industry and its eventual decline. 2.21 The CVD/SAD, which is levied to offset the excise duty imposed on domestic producers, is not applied on a
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ic production. This argument is faulty because the absence of competing domestic production may itself be the result of not having the neutrality of incentives that the CVD creates. Domestic producers may have chosen not to enter because the playing field is not level. 2.24 Indian tax policy is therefore effectively penalising domestic manufacturing. How can this anomaly be remedied? Simply by enacting an exemptions-free GST. In one stroke the penalties on domestic manufacturing would be eliminated because the GST (central and state) would automatically be levied on imports to ensure neutrality of incentives. In effect, India would be promoting domestic manufacturing without becoming protectionist and without violating any of its international trade obligations under the World Trade Organization (WTO) or under India s free trade agreements (FTAs). 2.25 In the meantime, the effect of the GST can be partially simulated even now by eliminating the exemptions applied to CVD/SAD. The defaul
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ergence within India because production can be based on comparative advantage. In other words, implementing the GST will help the lagging regions catch up with the more advanced regions by making the former more profitable production destinations. The growth effect via the boost to investment 2.29 Under the current tax system, while the Union excise duties and State VAT applies to all capital goods, input tax credits are generally limited to manufacturing plant and equipment. For example, no input tax credits are allowed for the Union excise duties on capital equipment acquired for use in transportation, infrastructure, distribution, or construction sectors because these sectors are all outside the scope of excise duties which are applicable to manufacturing only. Similarly, no credit is allowed for the State VAT on capital goods acquired by the service sector (e.g., telecommunications, transportation, finance, insurance, and IT services). 2.30 Estimates vary on how much of current inv
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hence growth. 2.32 Assuming an elasticity of investment demand with respect to price to be -0.5, GST, by allowing full input tax credit for capital goods, could higher investment in capital goods by 6 per cent, resulting in 2 per cent higher investment (as machinery and equipment account for around one-third of total investment), which in turn could lead to incremental GDP of 0.5 per cent, assuming an incremental capital output ratio of 4. 2.33 Prior to the introduction of GST in 1991, Canada also had an excise duty regime similar to that in India. Studies for Canada estimated this beneficial impact of GST to be 0.5 per cent as a result of the GST at the federal level only. The extent of tax cascading in India is much greater because of more stringent rules in India for claiming tax credits. 2.34 In sum, investment is discouraged under the current system through the application of excise duties and VAT to capital goods, for which no set off or input tax credit is provided. This increa
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plicated tax structure (Table-4), more complex than that of most of the States, characterized by: a multiplicity of rates, including central excise (the most important), cesses, countervailing and special additional duties; a multiplicity of central excise rates-8 ad valorem and several specific rates; extensive exemptions, amounting to about 300 items compared to say 90 for most of the States. These exemptions amount to about 1.8 lakh crore, amounting to about 1.5 per cent of GDP; an incomplete base that stops at the manufacturing stage; and an exemptions threshold of 1.5 crore with exports and exempted goods not counting towards the threshold 3.4 In relation to services too, the Centre has a complicated rate structure. Although there is one statutory rate, in practice, there are 10 other rates because of so-called abatement which amounts to fixing a rate different from the standard rate and not allowing further input tax credits. Abatement is necessitated in some part because of unce
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Agate (Akik) stones and articles are state specific. a standard VAT rate for goods that in most of the States is typically about 12.5-15 per cent (compared with the standard rate of 12 per cent at the Centre) Centre and States 3.7 Another key difference between the Centre and the States, with implications for any future standard rate is that the States have a much larger portion of the base (more than 65 per cent) 10 taxed at the lower rate while the comparable number for the Centre is about 40 per cent. One reason is that States typically place intermediate goods in the lower rate category. The higher standard rate is therefore almost compelled by the fact of placing so much of the base at the lower rate. 3.8 One corollary is that the weighted average statutory rate for goods is 8.4 per cent and 7.5 per cent for the Centre and States, respectively. IV.ESTIMATING INDIA S REVENUE NEUTRAL RATE (RNR) UNDER THE GST 4.1 The Committee had the benefit of 3 technical approaches to estimating
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hich has more than one rate), which is applied to all goods and services whose taxation is not explicitly specified. Typically, the majority of the base will be taxed at the standard rate, although this is not true for the States under the current regime. 4.3 The essence of calculating the RNR is highlighted in the simple equation: t=R/B where t is the RNR, R is equal to revenues (both Centre and state) generated from existing sales and excise taxes, which will be replaced by the GST. The revenues to be replaced are estimated to be ₹ 3.28 lakh crore for the Centre, and ₹ 3.69 lakh crore for the States, including the revenues that will have to be compensated for the elimination of the Central Sales Tax (CST). The total amounts to ₹ 6.97 lakh crore (excluding revenues from petroleum and tobacco for the Centre, and from petroleum and alcohol for the States) or 6.1 per cent of GDP, with all numbers pertaining to 2013-14 (the date chosen for all the technical studies) and
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ectors, based on the 2011-12 national accounts. The following assumptions were made: (1) full compliance; (2) full pass-through of the GST into prices; (3) no behavioral response; (4) the GST has a single positive rate, and a zero rate on exports. 4.5 Under a standard scenario exempting health, education, financial intermediation and public administration, the GST s potential base is 59 per cent of GDP. Exempting basic food items in addition (essentially unprocessed foods) reduced the potential base to 55 per cent of GDP. However, exempting petroleum or electricity increases the potential base to 67 per cent of GDP-given that such items are largely consumed as inputs rather than final consumption, their exemption increases the base due to cascading. Assuming that the maximum revenue to be replaced is 6.1 per cent of GDP, these estimates for the GST tax base, ranging from 55 per cent to 67 per cent of GDP, suggest that the GST RNR rate, itself ranges between 9.1 (0.061/0.67) and 11.1 pe
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ll the States, the key assumption is that States collect revenues at the three rates (1 per cent, 6 per cent, and 14 per cent) in such a proportion so as to yield a total taxable base of ₹ 30.8 lakh crore. 4.9 In the second stage, the services base is estimated based on turnover data of 3.25 lakh firms from the newly available MCA database (this base is estimated at ₹ 40.8 lakh crore). 4.10 In a third stage, adjustments are made to this base to remove IT-related services, because a large part of them are exported, and to remove most of real estate and financial services from the base because of the manner in which these items will be treated under the GST. This adjusted base is then subject to an input-output analysis to deduct from the base taxable inputs used for service provision and also deduct services used as inputs into taxable manufacturing. All these adjustments result in an incremental services base (incremental to whatever has already been incorporated in goods)
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alculated. Unlike the indirect tax turnover approach but like the macro approach, this approach yields a combined base for goods and services, rather than separate bases for goods and services. 4.13 The profit and loss accounts provide data on value of supply of goods and services (which is equivalent to turnover) to which can be added imports of goods and services. This yields the tax base of at about ₹ 222 lakh crore in turnover terms. Deducting the exempt sectors from this base (petroleum, land component of real estate, the interest component of the financial sector, electricity, gem and jewellery, education, health, and agricultural produce) narrows the output tax base down to about ₹ 194 lakh crore. 4.14 Next, purchases are divided into 2 categories, those that reduce the base because of the availability of input tax credits and those that add to the base either because they are purchases by or from exempt sectors.13 The former include intermediate goods and services (
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T= Indirect Tax Turnover DTT=Direct Tax Turnover Source: Based on three approaches to estimating RNR V. RECOMMENDATIONS 5.1 Consistent with the Committee s terms of reference, we make recommendations on a number of issues: the RNR; the distribution of RNR between the Centre and States; the structure of rates; and the potential price impact of the GST. In addition, we make recommendations on other relevant issues: the bands for the GST; compensation, the treatment of precious metals, and the tax treatment of certain commodities such as alcohol, electricity, education, and health. The Magnitude of the RNR 5.2 Three different approaches have been presented to determine the RNR. Each has it merits and drawbacks because of the underlying assumptions made and the data used. Coming up with an RNR is as much soft judgement as hard science. We cannot be confident that any one number is the right one. Moreover, there is a certain endogeneity effect-like a Heisenberg Uncertainty Principle-that th
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ted for the national RNR, range from about 11.6 per cent under the Macro approach to 17.7 per cent under the ITT approach. Where does the truth lie? Critical assessment of the methodology of the three approaches 5.6 Each approach has advantages and shortcomings that are described below. The Empowered Committee of the GST has had the benefit of familiarity only with the ITT approach of the NIPFP and we will dwell to some extent on this analysis. The Committee would underscore that the focus on the ITT approach does not signify that it is superior to the other two; indeed, focusing on one approach can be limiting and misleading. 5.7 Five key features drive the results of the ITT approach: i. The assumptions of collections at the different rates determine the goods base for the States. We have obtained the actual data on such collections for16 States (Karnataka, Maharashtra, Andhra Pradesh, Gujarat, Tamil Nadu, Bihar, Odisha, Chhattisgarh, Delhi, Uttar Pradesh, Jharkhand, Rajasthan, Madhy
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important issue. Currently, States tax most intermediate goods at the lower rate. If these goods were shifted to the normal rate-as States have indicated they might be willing to do-there would be an effective expansion of the tax base. It may be noted that taxes on intermediates in a GST system are like withholding-collecting early on in the value added chain but refunding them later on. So, in principle, this shift of intermediate goods should not yield any additional taxes. But to the extent that the unorganized sector buys intermediates from the organized sector, this shifting will result in greater taxes because the withheld taxes on intermediates will not be refunded later in the chain because the buyer is outside the tax chain. The lost base from these two effects-cascading and withholding-is difficult to estimate. But we cannot assume, as the ITT approach does, that this estimate should be zero. Corporate income tax data allows a guesstimate of the cascading effect. iv. A simil
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es have two important merits. They help provide a cross-check for the ITT approach; perhaps more significantly, they highlight the need to validate the estimates generated by all three approaches. We turn to this validation in the next section. 5.11 All three approaches implicitly assume that there will be no benefits to the base and/or revenues from improving compliance and or improved growth consequent upon implementing the GST. But the macro approach does not assume current levels of compliance-as the other two approaches do-but a theoretical one which may or may not correspond to current reality. Recommendations and validation 5.12 Our recommendation is based first on making adjustments to the ITT approach:17 ₹ 3.12 lakh crore for the data-based revision to the States VAT base; ₹ 30,000 crore for the omission of sugar; ₹ 45,000 crore for the cascading effect; and ₹ 95,000 crore for the choice of the statutory rather than effective excise rate in quantifying
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of these effects. 5.17 For the cascading effect, the ITT approach had earlier estimated an addition to the base of 10% of the incremental services base. The DTT approach estimates an addition to the base of about 16%. We, conservatively, estimate that the under-statement of the base would be half that assumed by the ITT approach which amounts to 45,000 crore. 5.18 For the compliance effect we draw upon cross-country experience. In Box 1, econometric analysis of that experience yields an estimate that a 1 percentage point reduction in the standard rate would increase the collection efficiency by 1 percent. The GST would lead to about a 4.1 percentage point reduction in the standard rate (in weighted terms) which would translate into a 4.1 percentage point increase in the C-efficiency or 9.3% increase in collection efficiency (based on the current C-efficiency of 0.44). This is equivalent to an expansion in the tax base of ₹ 4.3 lakh crore. Again, we assumed, conservatively, and af
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e rate structure will be significantly simplified from more than 10 rates (for both goods and services) and numerous exemptions to 2-3 rates and fewer exemptions; At the Centre and the States, significant improvements in compliance will result because of the IT systems under which matching of supplier and purchase invoices will be electronic and instantaneous, reducing the scope for fraud and evasion; this will also improve compliance for direct taxes; General compliance will improve because of dual monitoring by the Centre and the States; and The comprehensive definition of taxation of goods and services should result in a smaller amount of the base falling through the cracks between goods and services as happens currently. The elimination of abatements on services will reduce overstatement of input tax credits. 5.21 The experience of all countries suggests improvements over time in GST implementation, and in India s case, a number of design features should contribute to such improvem
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l the approaches, including our recommendation, we must independently validate them against other benchmarks. One important benchmark for validation relates to the efficiency of the tax system. A commonly-used measure of performance of a VAT system is to compute a C-efficiency ratio. This is measured as: C-eff=R/(S*C) where R stands for revenues collected, S is the standard rate and C is total final consumption (net of value-added taxes). The denominator is a measure of the potential revenues that can be potentially collected and the numerator actual collections. C-efficiency is simply a measure of comparing actual against potential. The C-efficiency implied by the three approaches and the Committee s recommendations are then compared against C-efficiency in a number of other countries and this comparison is shown in Figure 1. 5.25 The average C-efficiency is about 0.6 for high income countries and 0.57 for emerging market countries, and 0.31 for low income countries. The C-efficiency
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s would place India at levels comparable to other countries.19 Our recommendations yield estimates for the RNR that are at or below the average of other EMEs. In that sense, they are conservative estimates for the RNR because they too imply similar levels of efficiency of the Indian tax system. 20 5.28 Another consideration can be invoked to support the RNR of 15-15.5 per cent. Suppose this RNR requires to be operationalized in a two rate GST structure with a lower rate of say 12 per cent and a standard rate of 17-19 per cent, depending on how goods are allocated between the lower and standard rate. 5.29 Figure-2 shows data on the standard rate of VAT in selected high income and large emerging market economies. It shows that the average standard rate for comparable EMEs is 14.4 per cent and the highest standard rate is 19 per cent; and even for the high-spending and therefore high-taxing advanced economies it is 16.8 per cent. An RNR of anything beyond 15 – 15.5 per cent will likely re
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NR that is a little low or a little high? 5.31 One risk of setting an RNR that is low is the re-emergence of a trust deficit between the Centre and the States as happened in relation to compensation for lost CST revenues after the global financial crisis. If revenues fall short, and the fiscal position of the Centre and States is affected, the Centre will face a double whammy, with weak revenues for itself and an additional burden of having to compensate the States. And, if as a result, compensation is delayed or diluted, a trust deficit could re-emerge. 5.32 The second risk of setting a low RNR is that it could interact with slower growth and/or weaker buoyancy going forward to magnify the revenue shortfall. 5.33 On the other hand, some of these risks can be overcome. In the event of a revenue shortfall, the Centre and the States can both raise non-GST taxes (petroleum, tobacco and tobacco products, and alcohol); they can together raise GST rates; and, as a last resort, the Centre cou
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ns. The paper trail of the GST will also help direct tax administration and improve compliance in collections of corporate income taxes. 5.36 Third, the price consequences of a GST will be small, especially under a dual rate structure with essential food items exempted. As the analysis in Section V reveals, an RNR in the 15-15.5 per cent range with a lower rate of 12 per cent and a standard rate of 18 per cent would have no aggregate inflation impact. But a higher RNR with a lower rate of 12 per cent and a standard rate of 22 per cent would increase inflation by between 0.3-0.7 percent. Care will have to be taken to ensure that the GST does not become the target of popular disaffection on the grounds that it fed higher inflation. In that respect a lower RNR is safer than a higher one, especially considering that the GST is inherently regressive relative to direct income taxes. 5.37 Fourth, there is also a perception issue. Today s GST rate is 14.36 per cent for services (now nearly 15
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mpensation for five years (despite the fact that when the state VATs were implemented, compensation was not required beyond the second year.) Allocation of RNR between Centre and States 5.39 The Committee s recommendations on rates are all national rates, comprising the sum of central and state GST rates. How these combined rates are allocated between the center and states will be determined by the GST Council. This allocation must reflect the revenue requirements of the Centre and states so that revenues are protected. For example, a standard rate of 17% would lead to rates at the Centre and states of say 8 percent and 9 percent, respectively because that is roughly the ratio of GST revenues that would have to be generated by the centre and states assuming that the 2013-14 data on which these estimates are calculated remain valid. It would be preferable to keep all other rates identical between the center and states to minimize distortions and facilitate compliance. The structure of r
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good initial intention of restricting exemptions to a few industries. 5.42 It is also worth emphasizing that exemptions need not, and often do not, result in low or zero tax burdens. If a product is exempted, the effective tax burden will depend on all the embedded taxes on inputs going into that product. If the move to the GST results in lower rates of taxation, it is possible that eliminating exemptions might actually reduce the effective tax burden. This is especially likely in relation to small scale industries (SSIs) which are likely to come within the scope of the GST because of reductions in the exemptions thresholds. The combination of input tax credits that they can reap combined with lower standard rates might result in SSIs facing lower tax burdens. Another hidden cost of exemptions is that it leads to effective tax burdens that can vary widely across goods, leading to a multiplicity of effective tax rates. 5.43 We would recommend that: The exemptions list be narrow, restric
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en to have a single rate. The tax administration benefits of having a single rate are substantial. However, in the years ahead, it may not be feasible to adopt a single rate GST system for social reasons. A 2-rate structure (or a modified 2-rate structure) may therefore be adopted. What should be the lower rate and the standard rate, and the demerit rate which would apply to a small group of luxury items? 5.46 Consider the following simple formula for determining the structure of rates: R = αLG + βSG + γSS + μDG Where R is the RNR, LG is the lower rate on goods, SG is the standard rate on goods, SS the standard rate on services; and DG the demerit rate on goods; α, β, γ, and μ are the respective shares of these four rates in the underlying tax base, and together add up to 1. 5.47 The first point to note is that the standard rate for goods and services must be the same because that is the raison d etre of the GST-to provide a common base for goods
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ncreases the lower is the low rate. The benefit for any industry group of seeking to reduce the tax on its output is directly proportional to the tax advantage: moving a product from 14 per cent to 6 per cent is worth more than moving a product from 14 to 12 per cent. And in fact the pattern in the States reflects this political economy at work. 5.51 So, if the RNR is close to 15 per cent, the effort should be to keep the low rate at about 12 (6 +6 each for the Centre and States) per cent. 5.52 As discussed earlier, a lot will depend on the magnitude of exemptions and decisions about what goods are taxed at the lower rate and at the demerit rate. One of the major items either exempted or taxed at a very low rate currently is gold, silver, and precious metals. If the Centre moves to the smaller list as recommended and the States shift more of their tax base, especially intermediate goods, toward the standard rate also as recommended, the pattern of standard rates will look roughly as fo
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nd it impact on Standard Rate RNR Rate on precious metals Low rate (goods) Standard rate (goods and services) High/Demerit rate or Non-GST excise (goods) Preferred 15 6 12 16.9 40 4 17.3 2 17.7 Alternative 15.5 6 12 18.0 40 4 18.4 2 18.9 Source: Committee s calculation. 5.54 It is now growing international practice to levy sin/demerit rates-in the form of excises outside the scope of the GST-on goods and services that create negative externalities for the economy (for example, carbon taxes, taxes on cars that create environmental pollution, taxes to address health concerns etc.). As currently envisaged, such demerit rates-other than for alcohol and petroleum (for the states) and tobacco and petroleum (for the Centre)-will have to be provided for within the structure of the GST. The foregone flexibility for the center and the states is balanced by the greater scrutiny that will be required because such taxes have to be done within the GST context and hence subject to discussions in the
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ically be merit goods and will either be exempt or placed in a lower rate category. A related feature will be that this share will decline for richer households. 5.57 But even if a good is a merit good, warranting an exemption or lower rate, policy makers will want to ask how effective that decision will be based on how well targeted the implicit subsidy will be, where the implicit subsidy is the difference between taxing a good at the standard tax rate and the lower or zero rate: if the poor also account for a large fraction of total expenditure on the merit good, then the subsidy will be well targeted; if, on the other hand, they account for a small share of the total expenditure, then the subsidy decision will come with the cost that most of the benefits of the subsidy will accrue to the relatively better off. 22 5.58 So, one can think of a commodity-wise benefit-cost analysis for determining the rate structure. The benefit could be thought of as the subsidy rate for the target grou
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. But there are a number of anomalies. The most glaring is gold, silver and precious metals. They are a strong demerit good: the very rich consume most of it (see Table 2 in Box 3 which shows that the top 2 deciles account for roughly 80 percent of total consumption) and the poor spend a small fraction of their total expenditure on it; moreover, they have become a source of macro-economic instability and less important as a savings vehicle. Indeed, it is inconsistent for the government to actively promote schemes (gold bonds and gold monetization) to wean consumers away from gold, on the one hand, and also give highly concessional tax rates to buy gold, on the other. For all these reasons, these commodities should in principle be taxed at the standard rate: instead they are taxed at about 1-1.6 percent (center plus States). This anomalous treatment must be rectified at least by raising current tax levels to 4 or 6 percent (see Box 3). Education, health (excluding medicines), and electr
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tate in its entirety in the GST. Exemptions threshold 5.61 The current situation and proposed thresholds are described in Table 8. (Compounding refers to the exemption of firms from the VAT chain; instead they are charged a small turnover tax without allowing for any input tax credits). Setting an exemptions threshold has to balance three considerations. 5.62 First, minimizing the burden on small taxpayers would call for higher thresholds. Second, a high threshold also achieves social objectives because poorer households are more likely to buy from smaller outlets (such as kirana shops). Third, on the other hand, a high threshold not only risks foregoing revenues but also undermines the value-added chain that is so critical for the governance benefits of having a GST. The current proposal is to have a common threshold of ₹ 25 lakh for goods and services combined but raising this threshold say upto ₹ 40 lakh may be considered. Table 9: Exemption Thresholds: Current and Propo
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ld. 5.64 That said, the concern that reducing the threshold will raise the tax burden faced by small scale industries (SSIs) may need to be reviewed. Under plausible scenarios, the effective burden on SSI plants can actually decline, if the standard rate (currently around 25-26% in goods for the center and States combined) comes down, as envisaged by the Committee (see the illustrative example in the Annex Table). Rates or Rate Bands and the issue of fiscal autonomy of States under the GST 5.65 The proposed GST bill provides for States to have a band of 2 per cent above the standard GST rate so that they have some fiscal flexibility to adapt to state-level conditions. There are two reasons why this flexibility may need to be reassessed. First, the argument for fiscal flexibility/autonomy becomes less compelling: under the proposed GST, the States still retain considerable flexibility because alcohol and petroleum-the biggest sources of revenues for the States about 29 per cent of overa
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and reduce efficiency and increase compliance costs, especially for companies planning multi-state activities. These distortions and costs must be seen against the fact that they will not lead any meaningful additional fiscal autonomy to the states. 5.68 Rate bands would also create another complication for administering the CVD: under World Trade Organization (WTO) rules, the CVD has to be the lowest of the state rates. Supposing one state charged 8 per cent and another 12 per cent. The CVD would have to be based on 8 per cent, which would immediately disadvantage production in the state charging the higher rate, undermining Make in India programme. Potential price impact of GST24 5.69 In principle, the GST should have no aggregate impact on inflation and the price level because the new rate will be a revenue neutral one. Revenue neutrality may, however, not be enough to guarantee that there will be no price impact across all categories of goods and services. This is because the weigh
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from excise, and 47% of CPI is exempt from sales tax (Figure 5)25. Excluding taxed items that are outside GST (e.g. alcohol, petrol and diesel), 54% of the CPI would be GST exempt. 5.72 Second, most items, where not exempted are taxed at a lower rate. Thus, in addition to exempted commodities, a further 32% is taxed at a low rate, and only 15% at a normal rate (Figure 6). The 4% taxed at a high rate are mostly the items excluded from GST, like petrol, diesel and alcohol. 5.73 The taxation of some essential commodities in the CPI is shown in Figure 7. Most of the categories with a large CPI weight have traditionally been taxed at low rates to reflect distributional concerns; that is, these are goods and services which are important for poorer sections of society and hence are taxed at zero or low rates. In some cases, while the headline tax rate is zero, the effective tax rate is higher given the taxes on inputs. For example, the headline average tax rate on cereals is 2.3%, and vegeta
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s is an important point to emphasize: exemptions do not lead to zero taxation because embedded taxes via inputs cascade into the final product. 5.76 Because of the PDS, however, these taxes are offset by food subsidies so that the net tax rate is negative for the B40 and close to zero for the T60. The magnitude of the impact of the PDS, however, varies by states-high in Tamil Nadu and low in Gujarat. A similar pattern of negative net taxes on the B40 can be observed in fuel and light because the PDS covers kerosene. 5.77 Taxes on health turn out to be among the highest (Figure 8): and the burden is higher for the bottom 40 per cent, as bulk of healthcare expenditure is on medicines (which are taxed at a higher rate than medical services), and particularly so for the bottom 40 per cent (Figure 9). Education taxes also turn out to be regressive, as the consumption of books and school supplies is a higher part of education spend for the bottom 40%, and tuition (mostly tax exempt) is a hig
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% of CPI that is food & beverages). We also assume that textiles and clothing are taxed at a low rate. We find that the normal tax rate would then apply to about 11.2% of CPI. 5.81 The category-wise effective tax rates for major categories in these scenarios are shown in Annex-5 (Figures 1-2), and the inflation impacts in Figures 10-14. 5.82 While assessing inflation, for each scenario we look at two outcomes: one if there is no input-tax credit26, and the second with input-tax credit. In each of the three scenarios, we assume that a change in the tax rate would drive the supplier to change pricing. In some cases, even if the headline tax rate does not change (particularly for the exempt categories) if the taxes on inputs go up, the producer may be motivated to raise prices. For example, if taxes on fertilizers go up, the rice or cotton producer may take price increases. The reality may fall between the two alternatives: even if GST credits start flowing in relatively fast, some pr
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(though not in all). As we have assumed the current tax rate to be an average of state tax rates, the average tax rate jumps from low single digits to the RNR, a substantial increase. 5.85 Dual-rate GST with a lower rate of 12 per cent and a standard rate of 18 per cent: This rate structure would correspond broadly to an RNR of about 15-15.5 per cent. As one can expect, this has low inflation impact given the small part of CPI that gets taxed at the normal tax rate (Figure 12 shows the sensitivity). An 18% standard rate would impact CPI by -0.1% if all producers reacted to headline tax changes and 0% if they reacted after adjusting for input tax credits as well. Under this dual rate structure, food and beverages would see virtually no price increase and neither would fuel and light, which would be especially important for protecting poorer consumers (Figure 13). 5.86 Dual-rate GST with a lower rate of 12% and standard rate of 22%: This rate structure would correspond broadly to an RNR
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te of 18 percent would have negligible inflation impact. A higher RNR with a lower rate of 12% and a standard rate of 22 percent would have 0.3-0.7% impact on aggregate inflation. However, under both these scenarios, if food and fuel and light were exempted, and with the PDS in operation, the price impact on these items of consumption for the poor can be minimal. 5.91 These aggregate calculations would depend on a number of details in the design of the eventual GST, including: a) Final synchronized exemption lists; b) The choice of categories to which low-rates are applied; c) Exemption threshold for enterprises: a low threshold would mean that more producers/sellers pay GST, and thus re-price their goods/services, whereas a high threshold would bring that down (some categories like food could be particularly sensitive to this choice). In many categories the bulk of the goods/service are accessed through suppliers/outlets that don't pay tax (e.g. if all barbers/beauticians paid ser
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havior that hurts consumers via excessive price increases. Compensation 5.93 Under the proposed agreement on the GST, the Centre has agreed to compensate the States for any shortfall in their indirect tax collections in the transition from the current state VAT and other taxes to the unified GST. This compensation will be provided for 5 years. In the earlier experience of implementing the state VATs the Centre provided compensation for three years but at a declining rate: 100 per cent of the shortfall in 2005-06, 75 per cent and 50 per cent in the following two years respectively. 5.94 In the aggregate, of course, the States should not suffer any loss in revenues because that is intrinsic to the calculation of a revenue neutral rate. That is, if the RNR for the States is set appropriately, States as a whole should have the same revenue as before. But there are two situations why shortfalls may arise. First, the aggregate RNR might be set too low. In this case, of course, the GST Counci
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States is simply not possible. Moreover, the taxable base of States will also depend on rules on supply of goods and services and changing behavior of firms in response to these rules (for example, headquarters and where supplied). For these reasons, this report has chosen not to provide state-wise RNR calculations. 5.97 But we undertake an illustrative exercise in Box 2 to show that anxieties of some of the major States may be unwarranted and that the compensation requirements may well turn out to be minimal. We project the likely future tax base of goods consumption using NSS data and likely future tax base of services by estimating urban incomes. We find that the share of the future tax base for States is very similar to their share in current GST revenues. For those States that receive a large share of current revenue because they have a large manufacturing base, their anxieties can be reassured on the grounds that such States are also likely to have a large base in services going
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accordingly. 5.101 Going forward, there might be one issue in applying the same methodology to GST compensation. In some of the last five years, revenues witnessed unusually high levels of growth because of the combination of high real GDP growth and high inflation. The average of the highest three revenue growth figures for the last three years (for the States as a whole) was over 16.8 per cent; and the corresponding average of highest three nominal GDP growth figures was 13.4 per cent. 5.102 Looking ahead, this picture could change dramatically both because real GDP growth has slowed but more important because inflation has declined dramatically and is expected to remain low. For example, in FY2016, nominal GDP growth is expected to be about 9.5 per cent and the forecast for the period ahead is in the range of 11 per cent and rising slowly on expectations of a pick-up in real GDP growth. Now, if historical buoyancy prevails, this will lead to substantially lower collections which wou
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nt conjuncture. But this is at odds with the aim of improving governance and reducing rent-seeking which is pervasive in relation to alcohol. 5.105 Leaving that aside, there is still little reason to exclude alcohol constitutionally. Far better to leave it in, and to allow the Centre and States at some future date to decide collectively to bring alcohol within the GST net-like foreseen for petroleum products. To leave it out is to rule out even the possibility of choice for all time which cannot be good policy. 5.106 Another misconception pervades discussions of bringing alcohol in the GST. Bringing alcohol into the scope of the GST need not take away the right of States to tax alcohol. As is envisaged for tobacco, it is perfectly possible-and indeed desirable-for some basic tax to be levied on alcohol within the GST, and allow States to levy top-up sin taxes on alcohol for other revenue or social reasons. In other words, bringing alcohol within the scope of GST would not curtail State
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wth and employment-enhancing reforms. It is a reform that is long awaited and its implementation will validate expectations of important government actions and effective political will that have, to some extent, already been priced in. 6.3 Getting the design of the GST right is therefore critical. Specifically, the GST should aim at tax rates that protect revenue, simplify administration, encourage compliance, avoid adding to inflationary pressures, and keep India in the range of countries with reasonable levels of indirect taxes. 6.4 There is first a need to clarify terminology. The term revenue neutral rate (RNR) will refer to that single rate, which preserves revenue at desired (current) levels. In practice, there will be a structure of rates, but for the sake of analytical clarity and precision it is appropriate to think of the RNR as a single rate. It is a given single rate that gets converted into a whole rate structure, depending on policy choices about exemptions, what commodit
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te structures that depend on policy choices made on exemptions, and the taxation of certain commodities such as precious metals. The summary of recommended options is provided in Table 10 below. Table 10: Summary of Recommended Rate Options (in per cent) RNR Rate on precious metals Low rate (goods) Standard rate (goods and services) High/Demerit rate or Non-GST excise (goods) Preferred 15 12 40 Alternative 15.5 12 40 Source: Committee s calculations. Note : All rates are the sum of rates at center and states On the RNR, the Committee s view is that the range should between 15 percent and 15.5 percent (Centre and states combined) but with a preference for the lower end of that range based on the analysis in this report. The Committee has noted the risks both of setting rates that are marginally high and low. On balance, however, it is easier to address the consequences of erring on the side of marginally low rates. On structure, in line with growing international practice and with a vie
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within the GST context and hence subject to discussions in the GST Council. Accordingly, the Committee recommends that this sin/demerit rate be fixed at about 40 percent (Centre plus states) and apply to luxury cars, aerated beverages, paan masala, and tobacco and tobacco products (for the states). The GST also represents a historic opportunity to rationalize the tax system that is complicated in terms of rates and structures and has become an Exemptions Raj, rife with opportunities for selectivity and discretion. Tax policy cannot be overly burdened with achieving industrial, regional, and social policy goals; more targeted instruments should be found to meet such goals, for example, easing the costs of doing business, public investment, and direct benefit transfers, respectively; cesses should be reduced and sparingly used. Another problem with exemptions is that, by breaking up the value added chain, they lead in practice to a multiplicity of rates that is unpredictable, obscured, a
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% would lead to rates at the Centre and states of say 8 percent and 9 percent, respectively. The Committee considers that there are sound reasons not to provide for an administration-complicating band of rates, especially given the considerable flexibility and autonomy that states will preserve under the GST, including the ability to tax petroleum, alcohol, and other goods and services. Even in the future, when these products are brought into the GST, states should and will retain fiscal autonomy by being able to levy top-up taxes on demerit goods. Implementing the GST will lead to some uncharted waters, especially in relation to services taxation by the states. Preliminary analysis in this report indicates that there should not be large shifts in the tax base in moving to the GST, implying that overall compensation may not be large. Nevertheless, fair, transparent, and credible compensation will create the conditions for effective implementation by the states and for engendering trust
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ilitating easy implementation and taxpayer compliance at an early stage-via low rates and without adding to inflationary pressures-will be critical. In the early stages, if that requires countenancing a slightly higher deficit, that would be worth considering as an investment which would deliver substantial long-run benefits. Moreover, the counterpart of revenues falling short will be gains to consumers, especially poorer ones. Finally, the report has presented detailed evidence on effective tax burdens on different commodities which highlights that in some cases they are inconsistent with policy objectives. It would be advisable at an early stage in the future, and taking account of the experience of the GST, to consider bringing fully into the scope of the GST commodities that are proposed to be kept outside, either constitutionally or otherwise. Bringing alcohol and real estate within the scope of the GST would further the government s objectives of improving governance and reducing
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etting a tax rate or an exemptions policy in stone for all time, regardless of the circumstances that will arise in future, of the macroeconomic conditions, and of national priorities may not be credible or effective in the medium term. This is the reason India-and most credible polities around the world-do not constitutionalise the specifics of tax policy. The GST should be no different. 6.7 The nation is on the cusp of executing one of the most ambitious and remarkable tax reforms in its independent history. Implementing a new tax, encompassing both goods and services, to be implemented by the Centre, 29 states and 2 union territories, in a large and complex federal system, via a constitutional amendment requiring broad political consensus, affecting potentially 2-2.5 million tax entities, and marshalling the latest technology to use and improve tax implementation capability, is perhaps unprecedented in modern global tax history. The time is ripe to collectively seize this historic o
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tial. Revenue productivity (RP) simply replaces final consumption with GDP in the denominator. Simple regressions of the following form were run: CE (RP) = α + A*S + B*ln(Y) + DUM+μ Where the left hand side is either collection efficiency or revenue productivity; α is the intercept term; S is the standard rate; Y is the per capita GDP of a country which controls for other factors-such as quality of tax administration-that can affect collection efficiency; and DUM is a dummy for country groups arranged according to income to again control for certain group characteristics that might affect compliance; and μ is the standard error term. The regressions are shown in Tables 1 and 2. There is a very strong association between the standard tax rate and all measures of compliance even after controlling for per capita GDP and group dummies (Figure 1). For example, for collection efficiency the coefficient (A) is about (-) 1.22. This suggests that a 1 percentage point increase
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Collection efficiency (Revenue/(Standard Rate* Consumption)) Table 2: Regression Results of Productivity (1) (2) Estimation 3 Estimation 4 Log per capita GDP 2.66* (1.34) 1.02 (2.46) Standard Rate -0.81*** (0.29) -0.85*** (0.31) Constant 27.87** (12.53) 38.29* (21.51) Income Group FE Observations 84 84 Adjusted R2 0.088 0.076 Standard errors in parentheses * p < 0.10, ** p < 0.05, *** p < 0.01 Productivity (Revenue/(Standard Rate* GDP)) Box 2: Will There be Large Compensation Requirements? An Illustrative Exercise The GST will necessarily entail some shift in revenues from production to consumption and from manufacturing toward services. This shift is desirable but has raised concern especially from the major manufacturing producing States that they might suffer some loss in revenues. As noted earlier, it is nearly impossible to construct reliable tax bases-both new and old-at the level of the States, especially for consumption of services. Hence, this report has refrained fr
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latter by multiplying urban population by state per capita domestic product28. This will under-estimate urban incomes to the extent that urban per capita incomes are disproportionately greater than rural per capita incomes especially in more urbanized States. We define, analogously to goods, each state s share in total consumption of services as SSi . Then each state s share of the total potential GST tax base (goods and services) can be defined as: STi = α SG i + (1-α) SSi Where α refers to the share of goods and (1-α) the share of services, respectively in the overall GST base. We plot in Figure 1 below, each state s share in the total GST revenues to be compensated (on the y-axis) (current tax base) against the state s share of total potential GST tax base (future tax base) as defined above (on the x-axis). In this figure the weights assigned to goods and services are 45 per cent and 55 per cent, respectively. A 45 degree line is also fitted to the chart whic
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ons described above continue to hold. In sum, we cannot be sure that the GST will lead to large shifts in the tax base away from the advanced manufacturing States but the evidence presented above should provide some reassurance that these shifts will not be seriously adverse for the country as a whole and also for the large manufacturing States because they will also be substantial consumers of services. Box 3. Evidence-based tax policy? Incorporating social policy objectives in the GST Once the RNR is known, it has to be operationalized by making decisions relating to: exemptions, the structure of rates, including how many rates to have, and whether to have a separate lower rate for merit/essential goods and a higher rate for de-merit or sin goods; and the threshold below which firms will not have to be part of the GST tax administration. Typically, the assignment of goods to different tax categories will be motivated by considerations of equity. Goods that account for a large share o
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isions based on evidence: equity and effectiveness. Equity allows for categorization of goods as merit/essential/sensitive (hereafter merit ), etc. Goods that account for a high share of expenditure of the poorer households will typically be merit goods; and a related feature will be that this share will decline for richer households. But even if a good is a merit good, warranting a lower or zero rate, policy makers will want to ask how effective that decision will be based on how well targeted the implicit subsidy will be, where the implicit subsidy is the difference between taxing a good at the standard tax rate and the lower or zero rate: if the poor also account for a large fraction of total expenditure on the merit good, then the subsidy will be well targeted; if, on the other hand, they account for a small share of the total expenditure, then the subsidy decision will come with the cost that most of the benefits of the subsidy will accrue to the relatively better off. 29 So, one
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effective subsidy rate, which is the subsidy as a share of the total expenditure of the target group. The horizontal axis depicts the costs measured as the share of total subsidy on any given product that leaks to the non-target group. Three circles are drawn to highlight desirable evidence-based choices: commodities in the north- west corner of the graph circled in red are socially worthy of exemption because the benefits are high and the costs are low. These include cereals, vegetables, pulses, edible oils, and fuel and light (excluding electricity). Conversely, commodities in the south-east corner of the graph, circled in blue are less worthy of being treated favorably in tax terms because the benefits are low and the costs high. These include gold, non-medicine health services, education, and power. In the middle are commodities, circled in green, that lie somewhere in between that are perhaps worthy of being included at the lower tax rate. These include milk, poultry products and
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its on the taxes embedded in it by way of the inputs that have gone into it. If rice flour is exempted, for example, the tax paid on milling will be reflected in the price paid by the final consumer. This, of course, would not be the case, if that good were charged a lower tax rate because in this case input tax credits would be availed of. In other words, the difference between a good being taxed at a lower rate say, 5 per cent and exempted could be less than 5 per cent (5-0) because of embedded taxes.32 How do we measure embedded taxes? As part of inputs for this Committee, the World Bank, as an illustrative exercise, computed the embedded taxes for 11 categories of goods for the bottom 4 and top 6 deciles based on input-output tables and detailed data for five large States: Andhra Pradesh, Gujarat, Kerala, Karnataka, and Tamil Nadu.33 In Figure 2, the benefit cost ratio of exempting a good is shown on the Y axis and the effective tax rate on the X axis. In principle, the higher the
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re item for the poor. On balance, it warrants being taxed at the lower rate by both the center and the States. Gold, silver and precious metals Currently, gold, silver and precious metals face no central excise and most States tax these commodities at the non-standard rate of 1 per cent. There could be two reasons to under-tax these metals: for reasons of equity and to promote savings. Consider each in turn. It turns out that there is very little achieved by way of equity and a high cost is paid for exempting these commodities from taxation. Figures 3 and Table 2 illustrate these points. Gold as a consumption good constitutes a small portion of the total expenditure of the poor and a much higher share of the expenditure of the rich (Figure 3). It has the characteristics of a luxury good than an essential good. For example, the richest decile spends 3.5 per cent of its expenditures on gold, silver, and precious metals. In contrast the poorest decile spends about 0.03 per cent. Table 2 h
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her hand, gold far from being a desired savings instrument has become a problem, with large gold purchases and imports becoming a cause of macro-economic instability. Recognizing this, the government has recently tried to wean consumers away from gold via the gold monetization and gold bond schemes. It would be perverse and contradictory to use taxes to incentivize the holding of gold, and undo what the government is trying to do via these gold schemes. At the very least, tax policy should be neutral on consuming precious metals. Thus, on grounds of equity and effectiveness of targeting, on grounds of consistency of policy, gold should be taxed at the standard rate (bullion can be exempted from the GST). Instead, it is taxed at 1 percent, dramatically highlighting the incongruity of policy. The final point to make, of course, is that the more rational gold taxation can be, the lower will be the standard rate which will be critical in creating a buoyant and compliance friendly GST. As s
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clude power, health and education probably on the grounds that these are public goods, publicly provided, and of importance to relatively poorer sections of the population. But what evidence do we have on the underlying assumptions justifying such a policy? Figure 2 suggests that these sectors are perhaps under-taxed currently (They lie well below and to the left of the line of the best fit). The design of tax policy, thus, needs to more carefully take account of evidence. For all three sectors, the benefits of exemptions (even without taking account of any embedded taxes) for the poorer sections is small because these items constitute a small share of their total expenditure. For the top 6 deciles, these sectors are three times as important as they are for the bottom 4 deciles. Moreover, the top 6 deciles also consume such an overwhelming large share of these services (probably privately provided) that nearly all the benefits of the implicit subsidy go to the relatively well off. In t
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templated GST is a consumption tax of the VAT type. It would tax value added at each stage of the production-distribution chains of goods and services, with a credit/refund for taxes on inputs. The provision of a credit/refund to intermediate and capital inputs is the single most important design element of the GST; and, given the assumption of revenue neutrality, it is what mostly distinguishes it from the current system of federal/States sales and excise taxes, and what makes it a fundamental reform of the indirect tax system in India. The revenue implication of such reform can be analyzed using a simple macroeconomic framework, written as t=R/(C+G), where: t is the tax rate to be estimated, R is the revenue target, and C and G are, respectively, private and government final consumption of goods and services. In India s case, given the revenue neutrality assumption, R is equal to revenues (both federal and state) generated from existing sales and excise taxes, which India wants to re
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ions, and administrative data are of poor quality. National accounts data provide a more accurate picture of sectoral value-added and final consumption. Second, firm-level data do not always separate intermediate and capital inputs, which may receive different tax treatment under the GST – the methodology by A. Modi, which relies on tax returns of the corporate income tax, is interesting in that it uses depreciation schedules for income tax purposes as proxies for long-term capital consumption. Third, firm-level data rarely, if ever, contain a clear separation between supplies to export markets (which would be taxed at zero per cent under the GST), and supplies to domestic markets, which would be fully or partially taxed. Again, this is easily addressed with national accounts data. One of the main disadvantages of the macroeconomic approach is that national accounts data do not reflect misreporting of the tax base and the tax liability, while tax returns do (implicitly). Another disadv
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final consumption); and the summation is over 140 goods and services and 66 sectors, based on 2011-12 national accounts. The following assumptions were made: (1) full compliance; (2) full pass-through of the GST into prices; (3) no behavioral response; (4) the GST has a single positive rate, and a zero rate on exports. Under a standard scenario exempting health, education, financial intermediation and public administration, the GST potential base is 59 of GDP. Exempting basic food items in addition (essentially unprocessed foods) reduced the potential base to 55 of GDP. However, exempting petroleum or electricity increases the potential base to 67 of GDP-given that such items are largely consumed as inputs rather than final consumption, their exemption increases the base due to cascading. These estimates suggest that the GST RNR rate, assuming maximum revenue to be replaced of 6 of GDP, ranges between 9 and 11. Among the assumptions listed above, compliance is perhaps the most importan
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n tobacco products is to be realized through non-rebatable excises, for the purposes of the present exercise, it is assumed that one fourth of the revenue from tobacco products would be realized from GST. Table 1: Summary of Revenue to be compensated for all States combined (Rs crore) Tax Heads Revenue to be Compensated CST (including ITC adjustment) 38338 VAT & Sales Tax (excluding Non-VAT) 278232 Non VAT (collected on services/works contract) 1047 Entertainment Tax 2138 Lottery, Betting & Gambling 608 Luxury Tax 1946 Entry Tax not in lieu of octroi 15896 Entry Tax in lieu of octroy 20772 Toll tax not in lieu of service charges 552 Cesses & Surcharges 4742 Advertisement Tax 1 Purchase Tax 4559 ITC Reversal 11677 TOTAL 535722 Revenue to be Compensated (4 per cent) 407167 Revenue to be Compensated (2 per cent) 368829 To derive the tax base for GST, we have broken down the exercise into two parts – one, to derive the base corresponding to goods, we have used the revenue colle
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ities which will be brought into tax under GST and those that would remain outside the base, i.e, liquor, diesel, petrol and ATF. We have used weighted average tax rates for the estimation of taxable turnover from the data on tax collected under entry tax not in lieu of octroi and VAT excluding those which would not form part of the GST, viz., liquor, diesel, petrol and ATF. Further, since state VAT is applied on a base inclusive of excise duty, the base is deflated by 1.1236 to derive the base net of taxes.34 To this is added an estimate of the likely base from entertainment tax assuming the tax rate is 30 per cent. This gives us the base corresponding to the taxation of goods under GST. Adding across all States, we get a base for the goods part of GST. Table 2: Revenues of the Central Government: 2013-14 (Rs crore) S. No. Type of duty Shared with States Not shared with States Total Tobacco Correction Basic NCCD Education cess* Others 1 CE duty a) Non Pol (excluding Tobacco products)
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valid activity code as per the NIC classification. Further, since the data for 2013-14 appeared incomplete since fewer companies where reflected for 2013-14 when compared to 2012-13, the data available for 2013-14 has been augmented by using information from 2011-12 and 2012-13. Before attempting these corrections, it would be useful to examine the data that is available for each of these years.(Table 3) The total number of firms reporting data in 2011-12 and 2012-13 appear to be much larger than those reporting for 2013-14. However, if one compares the number of firms with valid activity code and working in the supply of services, the differences are not that large – 3.56 lakh in 2012-13 as against 3.25 lakh in 2013-14. A comparison of turnovers suggests that while the overall turnovers in 2011-12 and 2012-13 are higher than those in 2013-14, the turnover of firms reporting to be service providers with a valid code is comparable to the turnover available for 2013-14. Table 3: A compa
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ng information in 2012-13 but not for 2013-14 and had a valid activity code, the data from 2012-13 has been extrapolated using the average growth rate for 2013-14 when compared to 2012-13. Step 2: For all companies for which there was no description and/or no valid activity code, all companies with turnover above ₹ 100 crore have been individually explored and classified into an appropriate activity code. These companies account for 89.88 per cent of the total turnover of uncoded companies. Table 4 below summarises the numbers after each of these steps and Table 7 provides estimates of the size of the additional base subsequent to all corrections using MCA database. Table 4: Computing Total Turnover for the year 2013-14 (Rupees in crore) Steps Steps Turnover 1.Data provided for 2013-14 3412732 2.Including companies for which data from 2012-13 was extrapolated for companies with valid activity code 3974753 3.Turnover without activity code in 2012-13 1511747 4.Turnover classified t
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is component will not add to the taxable base for GST. Based on an IBEF study, the domestic supply of computer services is 30 per cent of total sales value of computer related activities and hence this 30 per cent is included in this study for arriving at the net additional base available for taxation. 2. From decisions taken so far, it appears that taxation in the real estate sector would be limited to the extent to which it is taxed today through taxation of works contracts and pre-completion sales of properties. To incorporate this view, the turnover from service tax collections is given primacy. 3. For financial services, there are two difficulties. First, the coverage of financial services tends to be incomplete being largely limited to fee based services. The present regime of taxation of financial services within Service Tax too is of this form. There is no clear indication to suggest that a radically new approach would be adopted in the proposed GST regime. Therefore, the base
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on line infrastructure 1 0 46 Trade 1 0 47 Commission agent services & Retail outlets 1 0 491 Rail Transport 0.1582 0.8175 1553 492 Road Transport 0.1130 0.5328 24979 493 Transport via Pipeline 0.1130 0.5328 16376 50 Water Transport 0.1803 0.4931 5778 51 Air Transport 0.2265 0.4523 24462 521 Storage and Warehousing 0.0739 0.9894 1397 522 Other transport service activities 0.0624 0.6605 4910 55 Hotel and Restaurant 0.1833 0.1887 36394 61 Post & Telecommunication 0.1020 0.7716 49069 62 & 63 Computer related activities 0.0425 0.1256 116242 64, 65 & 66 Banking and other financial services 0.0361 0.6151 110927 42, 68, 77 Real Estate 0.5523 0.4202 126995 72 & 85 Research & Development and Education 0.0075 0.0112 50295 70, 73, 74, 78, 79, 80 & 82 Business services 0.0788 0.9947 7550 84 Public administration 0.0000 0.0000 3781 86 Health 0.2256 0.0231 2177 93, 94 O.com, social & personal services 0.1123 0.4170 43668 Others / Undifferentiated services 0.0765 0.356
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Table 6: Additional base for GST: Alternative estimates Value (Rs crore) As of relevant GVA Incremental Services Base (MCA) 853235 15.87 Services GVA (2011-12 series) 5376045 Total GST Base (MCA) 3936610 37.57 GVA Total 10477140 Table 7: Revenue Neutral Rates: Alternative Scenarios 2 per cent Single rate Standard rate Scenario 1 Centre 8.33 10.42 State (Average) 9.37 12.34 Total 17.69 22.76 Scenario 2 Centre 8.33 10.42 State (Average) 8.88 11.44 Total 17.21 21.86 To consider an alternative case within scenario 1, if one proposes a 30 per cent tax on all transport vehicles (15 per cent for the Centre and 15 per cent for the States), and retain only the 1 per cent tax on gold and bullion, what will the RNR look like. From the National Accounts Statistics, output of manufacturing in organised sector in transport equipment is ₹ 652251 crore. Assuming that value added subsequent to manufacturing, including trader margins and transport costs is 10 per cent of this value, the value of s
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8 II. Revenue not adding to the base, of which 71517 a. CST 38338 b. Lottery, betting and gambling 608 c. Luxury tax 1946 d. Entry tax in lieu of octroi 20772 e. toll taxes 552 f. cesses and surcharges 4742 g. Advertisement tax 1 h. purchase tax 4559 Considering the single rate case in scenario 1 above, the RNR excluding revenues from II above would be 7.55 per cent with the overall RNR being 15.88 per cent. Assuming that the rate structure for taxation in the state is 1 per cent, 5 per cent and 12.5 per cent, on bullion, lower rate and standard rate, the corresponding average statutory tax rate would be 9.05 per cent incorporating the fact that VAT is levied on a base inclusive of excise. In other words, the RNR gets placed below the average tax rate. On the other hand, if one sought to find resources for all the taxes incorporated in category II, then the RNR increases to 9.37 for the States and 17.69 overall. Table 9: Impact on RNR of design of GST State rate Overall rate RNR exclud
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: the subtractive – direct (accounts) method; and 4) t (output) – t (input) : the subtractive – indirect (the invoice or credit) method. 3. While there are four possible ways of levying a VAT, in practice, the method used (number 4) never actually calculates the value added; instead, the tax rate is applied to a component of value added (output and inputs) and the resultant tax liabilities are subtracted to get the final net tax payable. This is sometimes called the indirect way to assess the tax on value added. Since in actual practice, input tax credit will be allowed only on the basis of invoice, we use the subtractive – indirect method for calculating the GST base and the consequential, revenue neutral rate (RNR). The present exercise is an attempt to calculate the single RNR using this method. Mathematically,- Total Revenues (R) = t* (output) – t*(inputs) = t* (output – inputs) = t* (Base) or, Single RNR, t = R / Base 4. For the purpose of estimating the RNR, we use the extensive
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ed for indirect taxes to arrive at the value of supply of domestically produced goods and services (net of indirect taxes) (hereinafter referred to as net value of supply of domestically produced goods and services ); b. Since imports are liable to GST at the point of importation, the value of imports is aggregated with the net value of supply of domestically produced goods and services to arrive at the net value of domestically available goods and services . c. Since exports are zero rated in a GST regime, the value of exports is reduced from the net value of domestically available goods and services to arrive at the net value of goods and services available for domestic consumption or the aggregate output tax base . d. Similarly, the expense items on the debit side of the Profit and Loss Account, in respect of which input tax credit would be potentially available, are identified and appropriately adjusted for indirect taxes to arrive at the value of purchase of intermediate goods and
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and input tax base. h. The threshold limit is proposed to be increased to ₹ 40 lakh for both goods and services. Therefore, appropriate downward adjustment to the GST base is made to also reflect this. i. The aggregate output tax base is reduced by the aggregate input tax base to arrive at the GST Base . 6. The net value of supply of domestically produced goods and services is the aggregate of the value of (i) sale of goods; (ii) sale of services; (iii) other operating expenses; (iv) financial services (excluding interest) provided by financial companies; (v) Commission; and (vi) other income. The item other income as reported in the accounts excludes rent, interest, dividend, profit on sale of fixed assets, profit on sale of securities liable to STT, profit on sale of other investments, agricultural income and profit on account of currency fluctuation. In practice, a large number of professional entities report their gross receipts under this item since they do not view themsel
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be exempt from GST. After adjusting for the exempt sectors , the net value of supply of domestically produced goods and services for the taxable sectors is estimated to be ₹ 192, 80,272 crore. 8. Input tax base comprises of all goods and services used as intermediate inputs in the production of goods and services and on which output tax has been paid. The value of purchases of intermediate goods and services by all sectors is the aggregate of the expenditure on items listed in Table-1. These purchases can be classified as purchases from the primary sector, secondary sector and tertiary sector. The aggregate of purchases by all entities from these three sectors is estimated to be ₹ 183, 22,797 crore during the financial year 2013- 14. After adjusting for the exempt sectors, the aggregate of purchases by taxable sectors is estimated to be ₹ 158, 33,024 crore. 9. In the case of purchases from the primary sector (i.e. primary goods) like cereals and plantation crops, no
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uld be available since no output tax would have been paid by the registered dealer purchaser. Since there is no bifurcation of purchases from registered and unregistered dealers in the Profit and Loss Accounts, the amount of purchases from unregistered dealer needs to be estimated. Based on anecdotal information, it is estimated that 10 per cent of the purchases of trading goods and raw materials from the secondary sector is acquired from unregistered dealers on which no input credit would be available. The value of such purchases from unregistered dealers, by taxable sectors, is estimated to be ₹ 11, 86,501 cores during the financial year 2013-14. 11. Similarly, value of specific services and miscellaneous services purchased by taxable sectors, from unregistered dealers, are estimated to be 25 per cent and 40 per cent, respectively. This translates to ₹ 4, 36,619 crore and ₹ 6, 89,440 crore, for specific services and miscellaneous services, respectively. The aggregat
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se. In all other cases, downward adjustment has been made to both the output tax and input tax base. 14. In terms of the proposed GST Model, the tax base will include real estate to the extent that the present scheme of taxation will continue. In the light of this, the value of rental services has been excluded from both the output tax and the input tax base. However, in the case of land, no information is separately available for the amount embedded in real estate services. Since the value of land is included in both the output tax and input tax base, this amounts to a wash transaction having no impact on the GST base. 15. Under the GST, a threshold exemption is proposed to be provided for registration of dealers. Since no decision has yet been taken on the level of the threshold exemption, we assume that the same will be fixed at ₹ 40 lakh. Table -2 shows the distribution of taxpayers across turnover. As would be noted, there are 7442736 dealers with turnover below ₹ 40 l
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etween ₹ 2 crore and ₹ 5 crore 48910 158340 378129 1182874 427039 1341213 Between ₹ 5 crore and ₹ 10 crore 31696 226691 155235 1081062 186931 1307752 Between ₹ 10 crore and ₹ 100 crore 60571 1891079 124932 2800947 185503 4692026 Above ₹ 100 crore 14130 12579433 4186 1146675 18316 13726108 Total 661210 14965794 8770698 7561190 9431908 22526984 16. The comprehensive GST is intended to bring within its fold rail transport services also. The rail transportation sector is entirely under the Ministry of Railways which is not required to file a tax return. Therefore, the sample does not include rail services. Accordingly, based on the information contained in the National Accounts (2014), the GST Base in respect of rail services is estimated at ₹ 79,759 crore. 17. In the light of the aforesaid discussions, the step-wise calculation of the GST Base for base year 2013-14 is presented in Table -3. As would be noted, the GST base is determined at &#
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ue of purchases of primary goods Rs. In crs 1104545 6 Value of purchases from unregistered dealers Rs. In crs 2312560 7 Aggregate Input Tax Base (3-4-5-6) Rs. In crs 13022528 D Estimated value addition by dealers below threshold exemption of ₹ 40 lakhs Rs. In crs 63109 E Estimated value addition attributable to alcohol sector Rs in crs 25965 F Estimated value addition by Rail Sector 79759 G GST Base (B6-C7-D-E+F) Rs. In crs 5815262 H Revenues to be compensated 1 Centre Rs. In crs 327728 2 States Rs. In crs 368829 3 Combined (1+2) Rs. In crs 696557 I Revenue Neutral Rate (RNR) 1 Centre in percent 5.64 2 State in percent 6.34 3 Combined in percent 11.98 J GST Productivity Ratio 11345056 0.51 K GST C-Efficiency Ratio 9698671 0.60 Annex 4: The Possible Impact of the GST on Small Scale Industries (SSIs) Sl. No. Description Existing Position Under GST Remarks 1 Central tax rate a. Output 12 8 We assume that the GST rate would be 8 percent each for Centre and States b. Input 12 8 2 Stat
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ce of the products manufactured by SSIs would be lower under the GST regime if the SSIs pass on the benefit of lower tax incidence to consumers. Alternatively, their profitability would increase. Therefore, the new GST regime without SSI exemption will be more beneficial to SSIs. Annex 5: Effective tax rates by commodities under 3 GST scenarios Figure 1 (Scenario 1: a single rate GST of 14%) Figure 2 (Scenario 2: a dual-rate GST, with a low rate of 12%, a standard rate of 18%, and a high rate of 35%) Figure 3 (Scenario 3: Scenario 2 with just the standard rate changed to 22%). References National Council for Applied Economic Research, Moving to Goods and Services Tax in India: Impact on India s Growth and International Trade, 2009. Keen, Michael, Targeting and Indirect Tax Design, Inequality and Fiscal Policy, International Monetary Fund, 2015. Keen, Michael, Targeting, Cascading, and Indirect Tax Design, International Monetary Fund, WP/13/57, 2013. Keen, Michael, The Anatomy of the VA
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nt zero-rating of exports and how much will the GST improve upon it are questions that need further investigation. 2 Whether cascading is a serious problem and why is discussed by Keen (2013). 3 The proposed Constitutional Amendment bill provides for a 1 percent duty on inter-state sales for a limited period. We strongly recommend that this provision be deleted for the very reason that the CST militates against Make in India. 4 JPS Associates ( 2011), Economic Cost of Inter-State Barriers in Goods Traffic, 5 Leemput (2014), A Passage to India: Quantifying Internal and External Barriers to Trade. 6 World Bank (2014), Supply Chain Delays and Uncertainty in India: The hidden constraint on manufacturing growth. Report No: ACS14223, Republic of India Manufacturing Plan Implementation. 7 There will also be gains stemming from simplification of the documentation requirements under the GST. 8 The CVD exemption strips the tax from its effective way of taxing the informal sector – where imported
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empt with full refund (i.e. zero-rated). 14 The ITT approach also does not include in the base that component of imports of goods and services that is sold directly to consumers outside the dealer network. The Committee has not been able to quantify this omission. 15 There has been some uncertainty whether the states tax textiles products, especially man-made fibres. But it appears that most-even a preponderance of-states do not. In that case, the tax base could be substantially under-estimated. Textiles going as inputs into clothing would not add to the base as clothing products are subject to tax. But textiles going into other textiles production or sold directly to the consumer would add to the potential future tax base. The uncertainty on textiles taxation stems from the fact that the Centre gave up most of its power to tax textiles (in the form of Additional Excise Duties) to the States. For example, in 2002-03, the Centre collected ₹ 4369 crore in AEDs (the nominal value of
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standard rate by more than it lowers the foregone revenues from taxing these inputs: the measured C-efficiency improves as a result. 20 At the center, there are likely to be large revenue and base-enhancing effects which will increase C-efficiency. These include: a decrease in the magnitude of exemptions from 300 items to 90 items in line with the recommendations of the Empowered Committee. Currently about ₹ 1.8 lakh crore are lost in central excise exemptions of which a substantial proportion can be recovered; expansion of tax base from manufacturing to retail level; bringing precious metals, gold, etc. into the tax base and taxed at the lower rate; reduction in the exemptions threshold from ₹ 1.5 crore in the case of goods to ₹ 25 lakh; this will offset the raising of the exemptions threshold for services from the current level of ₹ 10 lakh. Offsetting some of these effects will be the fact that cascading could decline because of better administrative efficie
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Input-Output Table (IOT) for 2007-08 (this is the latest available); the 299 CPI items were then manually mapped to the 130 IOT categories. 27 The same regressions were carried out for more recent data (for the year 2012) for a set of 36 countries. The results are similar with a strong and significant negative association between collection efficiency and standard rates, although the coefficient is slightly smaller (close to 1). 28 At current market prices for 2011-12. 29 Ideally, of course, if governments had well-designed transfer programs, they would achieve the desired objective of helping poorer households by providing cash transfers and sparing the tax system from having to attain equity objectives. In practice, this is not always possible and in India DBTs are still a work-in-progress. See Keen (2015). 30 The analysis can be re-worked for other target groups, say the bottom 3 or 5 deciles. 31 Strictly speaking, the benefit calculation should deduct the extra burden on the targe
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ess of where their inputs are produced. The calculations have not fully reflected the input taxes (except for petroleum products), and given that not all input taxes can currently be claimed this means that current tax rates are effectively higher than what is reflected. Third, another factor that would increase the effective tax rates is central sales tax on the movement of goods between States. In future work, this will need to be captured. Fourth, the calculations use 2011-12 consumption aggregates but 2015 tax rates. Finally, the calculations assume not only perfect compliance, but also ignored threshold effects. Businesses below the VAT/Excise thresholds are not liable to collect tax, and this leads taxes to be overestimated, especially for the B40 who would be more likely to shop in businesses below the threshold. 34 The headline rate of tax for central excise was 12.36 per cent in 13-14. 35 Companies associated with electricity, gas and steam and construction for instance are ex
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