Term Paper

Macro Economics

GST & Its Implications on the Indian Economy

Submitted by

Group 1A
Aarti Mallya 2009001
Akhil Kamat 2009005
Purnima Tarkar 2009032
Sagar Khichade 2009040
Sangram Dhumal 2009042
Vijay Kulkarni 2009059

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Table of Contents
Introduction................................................................................................................................3
Current Tax System....................................................................................................................3
Drawbacks..................................................................................................................................5
Exclusion of services..............................................................................................................5
Tax cascading.........................................................................................................................6
Complexity.............................................................................................................................6
GST............................................................................................................................................6
Implementation..........................................................................................................................7
Alternative I: GST at Union Level Only................................................................................8
Alternative II: GST at State Level Only.................................................................................8
Alternative III: GST at both levels.........................................................................................9
Suggested GST Model & Implications.................................................................................10
Conclusion................................................................................................................................12
References................................................................................................................................13

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Introduction
Tax policies have an important role to play in the economics of a country. An efficient tax
system must keep in mind the issues of income distribution and at the same time generate
revenues to support the expenditure by the government on public services and development
of infrastructure. Goods and Services tax (GST) is considered to be one such efficient system
of taxation. The evolution of GST started with value added tax being first introduced by
Maurice Laure, a French economist in 1954. [ CITATION Raj09 \l 1033 ] This tax was designed
such that the burden is borne by the final consumer. VAT can be applied on goods as well as
on service and was termed as goods and services tax at a later stage. Since its inception, GST
has been adopted by 130 countries around the world and many developing countries
including India have started to move towards GST. [ CITATION Raj09 \l 1033 ]

India has posted very high growth rate since 1990s. Exports have become a very important
part of this growth. Exports constitute 25.6% of India’s 2008-09 GDP. [ CITATION EIR08 \l
1033 ] Competiveness of India’s exports has increased over time but gets impeded due to
some domestic hurdles and one such hurdle is an inefficient tax structure. India should adopt
the tax policies which will maximise efficiency and minimise hurdles in the optimum
allocation of resources and trade. India should also pursue horizontal equity rather than

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vertical equity. [ CITATION Raj09 \l 1033 ] Vertical equity is based on high rates of direct and
indirect taxes whereas horizontal equity is based on broad based taxes with low variance of
tax rates.

India has adopted reforms in its tax system since mid-1980s but there are various issues that
need to be looked into. This paper will give an overview of the current tax system of the
country, its drawbacks and the advantages and implications of adopting GST which will be
implemented in the country on 1st April 2011 according to the budget of 2010-11.

Current Tax System

India is growing at a very fast pace. Economic liberalisation and reforms have played a very
important role in the same. Tax reforms have also kept pace with this reforms and the country
has moved from an origin based system of taxes to a destination based system. India has
introduced tax on services and has adopted the more robust and efficient tax system based on
value added principles. The timeline of the various important reforms undertaken by India are
listed below:

1974 Report of L.K JHA committee – Suggests

VAT
1986 Introduction of restricted VAT called
MODVAT
1991 Report of the Chelliah committee-
Recommends VAT goods and service taxes.
(GST)
1994 Introduction of service tax
1999 Formation of empowered committee on state
VAT
2000 Implementation of uniform floor sales tax
rates
2003 VAT implemented in one state
2004 Significant progress towards central VAT
GST integration
2005 VAT implemented in 21 states
2006 VAT implemented in 5 more states

Source: [ CITATION SMa06 \l 1033 ]

At present, India has a mixed taxation system. Although the taxes on goods are described as
VAT at both the central and state levels, it is not the “classic” VAT or GST system.

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[ CITATION EIR08 \l 1033 ] The main differences between the current tax system and “classic”
VAT are as follows:
 There is no comprehensive tax on services at the state level, only a few services
(entertainment tax, electricity duty etc.) are taxed under separate enactments.
 Tax on goods and services is under a separate legislation at the centre level
 Imports are not subjected to VAT [ CITATION EIR08 \l 1033 ]
 Two separate VAT systems operate simultaneously at two levels, Centre and State,
and tax paid under one is not available as input tax credit against the other
 Union service tax is not comprehensive and is levied only on a large number of
selected services [ CITATION Ama09 \l 1033 ]

In the current system of indirect taxes in the country, the central government collects the
CENVAT and service tax whereas the state government collects the VAT. Tax on the
manufacturing activity and on the provision of services is under the purview of the central
government and tax on sale of goods is collected by the state government. The various tax
arrangements of the central and state are listed in the table below:

Central Taxes State Taxes

Customs Duty -Tax on imports Central Sales Tax (CST) – Tax on inter-State
sale of goods
CENVAT -Tax on manufacture State Value Added Tax/State Sales Tax –
Tax on intra-State sale of goods
Service Tax -Tax on specified services Works Contract Tax - Tax on contracts
involving sale of goods and services
Entry Tax - Tax on entry of goods into a
State
Other local levies

Source: [ CITATION SMa06 \l 1033 ]

Drawbacks
There are several drawbacks to the current system of tax followed in India. Some important
drawbacks are explained in detail below.

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Exclusion of services
The States are precluded from taxing services. This has given rise to a number of difficulties
involving the taxation of goods supplied as part of a composite works contract involving a
supply of both goods and services, and under leasing contracts, which entail a transfer of the
right to use goods without any transfer of their ownership. [ CITATION Sat09 \l 1033 ] These few
issues are solved by amending the constitution but services per se remain outside the scope of
state. This limitation is inefficient due to two reasons:

First, the development of information technology has clouded the distinction between
services and goods. Goods and services are bundled and sold to the final consumers under
different supply chain arrangements. Under the current system, neither the centre nor the state
can apply the tax in a full proof manner. [ CITATION Sat09 \l 1033 ] Each can levy tax only on
parts of the bundle thus creating gaps in taxation. Second major issue is the growing fraction
of services in the total consumer basket which deprives the states of a sizeable amount of
revenue.

Tax cascading
Tax cascading occurs under both Centre and State taxes. Oil and gas production and mining,
agriculture, wholesale and retail trade, real estate construction, and range of services remain
outside the ambit of the CENVAT and the service tax levied by the Centre. These exempt
sectors are not allowed to claim any credit for the CENVAT or the service tax paid on their
inputs. Similarly, under the State VAT, no credits are allowed for the inputs of the exempt
sectors, which include the entire service sector, real property sector, agriculture, oil and gas
production and mining. [ CITATION Sat09 \l 1033 ]

Another major contributing factor to tax cascading is the Central Sales Tax (CST) on inter-
state sales, collected by the origin state and for which no credit is allowed by any level of
government. [ CITATION Kum10 \l 1033 ] Tax cascading is a major issue of the current system
as it increases the cost of production and makes the Indian exports uncompetitive in the
international markets. It also favours imports as imports do not bear the tax on production
inputs.

Complexity
There are several improvements made in the tax system at both the central and the state levels
but still the systems remain very complex. The Indian tax system is one of the most complex

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systems in the world according to a few experts. The system is vulnerable to disputes and
court orders and the process of conflict resolution is very slow and expensive. Most of the
complexity and disputes is due to the exemptions and multiple rates. [ CITATION Sat09 \l 1033 ]

The major issue with state VAT is the different tax rate schedules. Theoretically, one might
expect that the lower tax rates would be applied to basic necessities that are consumed largely
by the poor. But this is not the case under the State VAT. [ CITATION Sat09 \l 1033 ] For
example: the lowest rate of 1% applies to precious metals and jewellery. Many of the
administrative processes are still manual, not benefiting from the efficiencies of automation.
This not only increases the costs of compliance, but also undermines revenue collection.

GST
GST is a broad based and a single comprehensive tax levied on goods and services consumed
in an economy. GST is levied at every stage of the production-distribution chain with
applicable set offs in respect of the tax remitted at previous stages. It is basically a tax on
final consumption. [ CITATION Kum10 \l 1033 ] To put at a single place, GST may be
defined as a tax on goods and services, which is levied at each point of sale or provision of
service, in which at the time of sale of goods or providing the services the seller or service
provider may claim the input credit of tax which he has paid while purchasing the goods or
procuring the service.

GST is seen as a ray of hope to minimise all the drawbacks of the current tax system in the
country. It will help to solve the most important issue of tax cascading. For example, when a
shoe company produces a pair of shoes, the Central Government charges an excise duty on
them as they leave the factory. At the retail level, the state where the outlet is located, charges
VAT (different states charge different rates of VAT) without giving credit on the excise duty
levied earlier (the state tax is levied on top of a Central tax). In the GST system, both Central
and state taxes may be collected at the point of sale. Both components (the Central and state
GST) may be charged on the manufacturing cost. [ CITATION Kum10 \l 1033 ]

This concept can be further highlighted in the table given below:

Stage of Purchase Value Total Rate of GST on Input tax Net

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 supply chain value of addition Value GST output credit GST
input
Manufacturer 100 30 130 10% 13 10 13-10=3
Wholesaler 130 20 150 10% 15 13 15-13=2

Source: [ CITATION DrP10 \l 1033 ]

The “Classic” GST integrates the union excise duties, customs duties, service tax and state
VAT into a single tax number. GST is levied not only goods but also services and the rate of
tax on goods and services are generally the same. [ CITATION SMa06 \l 1033 ]

Implementation
There are three alternatives to implement GST in India. The three options along with the
advantages and disadvantages of each are listed below.

Alternative I: GST at Union Level Only

This alternative suggests that the indirect taxes on goods and services are to be levied only by
the central government. State government will not be able to levy any tax thus leading to one
GST throughout the country. [ CITATION EIR08 \l 1033 ]

Advantages
Ideal structure from business perspective as it will lead to greater stability and facilitation
of decision making. Businesses will have to deal with only one tax authority and comply with
only one tax as a result of which there will be significant reduction of compliance costs
Excellent from consumer perspective as the consumer will know exactly how much is the
indirect tax burden on the goods and service consumed by it
Cascading effect can be removed to a large extent as there will not be taxes at two levels
Feel good factor for anyone doing business with the country

Disadvantages
Near impossibility of achieving the structure as it will require heavy modification of the
Constitution
States may not agree to give up power of taxation and depend entirely on the Union for
resources
Entire infrastructure and administration developed for taxation at both levels will have to
undergo huge change

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Alternative II: GST at State Level Only
This alternative suggests that the indirect taxes on goods and services are to be levied only by
the state government. There will be no GST by the central government. [ CITATION EIR08 \l
1033 ]

Advantages
Reduction of cascading effect of taxes as there will not be tax at two levels

Disadvantages
Amendments, will be required in the Constitution which may be supported by industrial
and large states and opposed by smaller states which do not have significant source of
revenues
Businesses will have to comply with tax laws of each State. This will not be worse off than
current situation but not better off as well except that they will not have to deal with Central
Level taxation which is the current position. At the same time, decision making will be
impacted and may affect business stability
Governments, both local and Union will not find it workable as it will require complete
change in its finances and allocation of resources. The entire distribution of taxes will need to
undergo changes. An option to this can be that the centre can retain entire direct tax
collection and states may retain indirect taxation collection. But, that too will not be workable
as revenue collection by each state will vary depending on the level of activities in each state
and need for support to states. Hence, redistribution of taxes will become an issue
There may be unhealthy competition among states using local tax structure as a tool to
attract investments within the states, which may be at the cost of other states. This could lead
to retaliatory measures by other states. [ CITATION Ama09 \l 1033 ]
Entire infrastructure and administration for taxation will have to undergo change as states
will need additional resources whereas Union’s infrastructure will be freed up.

Alternative III: GST at both levels

This model envisages GST at two levels operating simultaneously; one, at Union Level and
another at State Level. [ CITATION EIR08 \l 1033 ]

Advantages
Achievable in the short term

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No significant change required in the current structure of indirect taxation although, some
amendments may be required to the Constitution
Partial removal of cascading effect of taxes
No change required in infrastructure of tax departments at the Union and State levels

Disadvantages
Not an ideal model as tax would continue to be at two levels and compliance costs may not
reduce significantly
Constitutional amendments may be required – principal one being extension of CENVAT
to the consumer level and granting authority to states to impose taxes on services
Uncertainty of states changing laws, rates of taxation and like will continue affecting
business sentiments
Taxation of services at state level especially services provided nationwide (e.g.
telecommunication service, transportation service) will pose challenge.

Suggested GST Model & Implications

Looking at the advantages and disadvantages of the three alternatives, the third alternative of
dual GST looks more promising for the country and is recommended by all the committees
constituted by the central government. [ CITATION EIR08 \l 1033 ] This model is the most
workable model especially taking into consideration the changes required in the Constitution
and achievability in the short term. This Model builds on the current structure of taxation of
goods and services and does not need drastic changes in the broad mechanism for levy and
collection of taxes. [ CITATION Vol09 \l 1033 ] It results in allocation of taxes between Union
and States and between states based on fair and transparent criteria of consumption within a
state. This will increase the efficiency in tax administration and will also increase the tax
collection due to wide coverage of goods and services. It will also make the Indian products
more competitive in the international market.
The proposed GST by the Indian government is as shown in the flow chart below:

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Source: [ CITATION SMa06 \l 1033 ]

Experts have estimated that India stands to gain almost $15 billion [ CITATION Raj09 \l 1033 ] a
year after implementing GST as it will promote exports, increase consumption and boost
growth. Imports will be brought under the purview of GST and exports will be zero rated and
exporters need not pay any GST on exports. Also the GST paid by them on the procurement
of goods and services will be refunded. The main feature being that it will divide the burden
of tax equally between manufacturing and services. The central and state taxes will be
collected only at the point of sale and will be charged on the manufacturing cost. This will
boost consumption as prices will come down thereby helping companies. This will in turn
increase the employment opportunities in the country thus helping the growth.

The main problem in the application of GST will be to food as it will have an impact on the
people living at or below the subsistence levels. Food accounted for 33% of the total private
consumer expenditure according to the 2005 data. For the people at the bottom of the income
pyramid, this percentage is even higher. Taxing food will thus have a high impact on the
poor. But a complete exemption for food would significantly shrink the tax base. [ CITATION
Raj09 \l 1033 ] Given that food is currently exempt from the CENVAT in the current structure,
the GST under a single-rate, comprehensive-base model would lead to at least a doubling of
the tax burden on food (from 4% state VAT to a combined GST rate of 10-12%).

Manufacturing sector in India is one of the highly taxed sectors in the world. A very high tax
structure has the tendency to make the products uncompetitive in the market. The

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manufacturing cost of most products in India is half than in the west. But all the extra taxes
take away this advantage of 50%. [ CITATION Kum09 \l 1033 ] The extra taxes are: customs duty
on imports, central excise duty on manufacture, central sales tax (CST) / value added tax
(VAT) on sale of goods, service tax on provision of services and levies such as entry tax,
octroi and cess by the State or local municipal corporations and related costs such as loss of
tax credit, compliance and litigation cost. [ CITATION Kum10 \l 1033 ]

Besides the tax implications mentioned above, the state wise taxation systems have serious
effects as inventory and distribution centres are made for tax avoidance rather than for
operational efficiency. Also, the manufacturer spends on the ERP and other software linkages
to link all the warehouses. This has severe implications on the cost and efficiency levels
which are finally borne by the end consumer. [ CITATION Kum09 \l 1033 ]

A CRISIL Research report released in September 2009 estimates that the Indian logistics
spend was at Rs 2.7 trillion in 2008-09, which includes only primary transport mode and
infrastructure. This is equivalent to around 8.2 per cent of the Gross Domestic Product, and
shoots up to 10.7 per cent if the secondary movement (from the hub to various depots) is also
included. This is significantly higher than those of developed nations where it averages 5 to 7
per cent. With the implementation of GST, Tax avoidance will not be an issue and this high
expenditure can be reduced over a period of time. [ CITATION Gag10 \l 1033 ]

GST will be able to achieve lower tax rate by broadening the tax base and by minimising
exemptions. It will help to remove loop holes by switching to the destination principle. It will
facilitate investment decisions made on economic concerns and independent of any tax
considerations. GST will offer cash flow benefits to dealers and distributors. [ CITATION
Kum10 \l 1033 ] They would be collecting GST from their customers as they make sales, but
would be required to remit it to the government only at the end of the month or the quarter,
when they file their returns. This extra cash float would allow them to achieve scale and
invest in making their operations more efficient. GST will also give more relief to industry,
trade and agriculture through a more comprehensive and wider coverage of input tax and
service tax set-off, thus including several central and state taxes in GST.

Conclusion
Implementation of a comprehensive GST across goods and services is expected to increase
India’s GDP somewhere within a range of 0.9 per cent to 1.7 per cent. [ CITATION Tow09 \l

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1033 ] The additional gain in GDP, originating from the GST reform, would be earned during
all years in future over and above the growth in GDP which would have been achieved
otherwise. In short, GST would lead to efficient allocation of factors of production. [ CITATION
Gag10 \l 1033 ] The overall price level would go down which will foster our exports and make
a unified market of goods and services comprising of domestic products and imports.

References
Bagchi, A., & Poddar, S. (2009). GST For India.

Chadha, R. (2009). Moving to GST in India: Impact on India's Growth. National Council of
Applied Economic Research.

EIRC. (2008). GST Model For India.

India, V. H. (2009). Goods and Services Tax in India.

Madhavan, S. (2006). Roadmap to GST. Price Waterhouse Coopers.

Poddar, S., & Ahmad, E. (2009). GST Reforms & Intergovernmental Considerations.
Deaprtment of Economic Affairs, Department of Finance, GOI.

Saravanan, D. P. (2010, January 15). GST Act. Business Goa , pp. 30-31.

Satyakam, K. (n.d.). Retrieved 2009, from www.Indlawnews.com.

Satyakam, K. (n.d.). Goods and Services Tax: Future of India. Retrieved February 10, 2010,
from www.indlawnews.com.

Seksaria, G. (n.d.). India after GST. Retrieved Januray 29, 2010, from Maritime Gateway.

(2009). Towards More Efficient Tax. CARE Ratings.

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