GST: The population factor

The tug of war over the Goods and Services Tax (GST) between the central government and state governments has raised questions on when this system of taxation—which collapses a multitude of taxes into one—will be implemented. When it does, it will change many things, one of which will be how much a state collects by way of taxing goods and services, something that is especially of concern to states with larger industrial bases but smaller populations.

That’s because the basis of GST is different from the basis of the two main taxes it will replace. The first main tax in the present system is excise levied by the Centre: a tax on production, it benefits states with larger industrial bases. The second is VAT (value added tax): a tax on sales levied by states, it benefits states with larger population and consumption.

However, since a company cannot set off the excise paid by it against VAT, states with a higher share of manufacturing collect and retain more taxes than states with a large population and consumption. Basically, the two taxes don’t talk to each other.

GST will change that as it will be levied at the point of consumption, and not production. Thus, prima facie, it will tilt the balance in favour of states with higher population and consumption, even if they don’t have a large industrial base.

So, with GST, which states stand to gain and which stand to lose? This realignment will play out at two levels. Graph 1 below maps three variables at the state level: population (red line), area (blue circle) and tax revenue (green line). The first two are also determinants to calculate a state’s share in GST.

Thus, at the first level, a downward sloping line is indicative of high population states (Uttar Pradesh, Bihar and West Bengal), and they are likely to benefit from GST. An upward sloping line is indicative of states with large industrial bases (Tamil Nadu, Maharashtra and Gujarat), and they could be impacted by the point of sale becoming the point of taxation.

But it’s also true that several states in India with the largest industrial bases (notably, Maharashtra and Tamil Nadu) also have a large population and are leaders in per capita income. So, what these states lose in the first-level shift from manufacturing basis to consumption basis might be offset by their own consumption quotient.

The scatter diagram in Graph 2 below plots similar variables as Graph 1 (with the added nuance of tax per capita). So, for example, while a state like Tamil Nadu might lose revenues because of consumption-based taxation, its high tax per capita, an indicator of higher consumption, would offset this.

The net impact of both factors will determine how much a state loses or gains when GST is implemented.

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Get Smart Fast | Six things you have to know about GST

GST

 

Goods and Services Tax (GST)

Before delving into what GST is, let’s understand how taxes are collected in India. Taxes can be broadly classified under three buckets – income, production and consumption. The central government has the complete right (almost) to tax income and production in the form of income tax and excise duty. When it comes to consumption, both the central and state governments levy taxes in the form of service tax and Value added Tax (VAT). Income taxes are directly collected from people who earn salaries or companies that report profits. The others are paid by producers (Maruti Suzuki) or service providers (restaurants) but are collected from buyers. These are called indirect taxes.

 

What would the GST do?

It would merge almost all the indirect taxes into one tax that will be applicable all over India at a single rate. A car produced by Maruti would attract a single tax rate irrespective of where it is purchased.

 

Why do we need this Constitution Amendment Bill?

With GST, both the centre and the states will have powers to tax both production and consumption. States, at present, don’t have the powers to levy taxes on production, except on alcohol. Changing this means amending the constitution. And, amending the constitution requires two-third majority in both the Lok Sabha and the Rajya Sabha. Plus, half the states have to ratify the bill.

 

What happens next? Will GST be implemented from next month?

  • The Constitution Amendment Bill is like an enabling Act to roll out GST. The next steps include:
    50% of states have to approve the bill.
  • Once approved, both the centre and states will come out with laws that will administer GST.
  • The final decision on what the GST rate will be is yet to be taken. It could be 15% or 18%.
  • The technology and administrative platforms are being developed to handle paperwork but it remains to be seen when these could be rolled out.

Nevertheless, the Constitution Amendment Bill was the biggest task and it sorted out major issues. Now that there is a consensus, the rest would fall in place.

 

How will it benefit me?

It depends on the GST rate, which is yet to be agreed upon.

In 2010, Maruti’s Ritz attracted an indirect tax of 24%. This includes 12.5% VAT, 9% excise duty, 1-2% entry tax, 2% CST (Central Sales Tax), and registration charges.

Let’s say if the GST rate is 16%, then there will be a Rs 30,000 reduction in taxes. Of course, it depends on whether Maruti decides to pass on the benefit of this tax reduction.

If the GST rate is fixed at 18%, then all services will become costlier – from eating out to telephone bills – as the current service tax is at 15% including cess.

 

How will companies benefit from GST?

  • Optimal location of warehouses – at present, companies have warehouses in each of the states they operate. If they don’t do so, the dealer (who buys goods from the producer) has to pay CST of 2%. Now, CST would be absorbed into GST. Therefore, companies can locate warehouses to optimally distribute their goods.
  • Lower price could lead to higher demand – A reduction in price because of lower taxes will stimulate demand, and this in turn could lead to higher investments.

 

Are there any negatives?

Yes. Services account for more than half of the Indian economy. If the GST rate is higher than the 15% being levied now, then inflation will go up.

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