The Rise of Goliath

by AK Bhattacharya

  Politically, however, demonetization became a little risky for Modi. In his last Independence Day address as prime minister during his 2014–19 tenure, on 15 August 2018, Modi listed out all the major achievements of his government, but did not mention demonetization as one among them. Was that a slip or a deliberate omission? More significantly, the forty-five-page-long BJP manifesto for the 2019 elections, Sankalp Patra (released in April 2019), listed in great detail all the major achievements of the Modi government in the five-year period from 2014 to 2019. But demonetization as a word figured only once in the entire document, which listed the government’s achievements and the BJP’s promises along with short messages from Modi, BJP President Amit Shah and Rajnath Singh in his capacity as chairperson of the BJP Manifesto Committee. That word did not appear either in Modi’s message or in Rajnath Singh’s Sankalp Patra note. It was Shah who mentioned demonetization as one of the historic decisions that ‘ushered in a comprehensive and fundamental transformation’.27 The absence of emphasis on demonetization could be an outcome of the BJP’s realization that the experiment with annulling high-denomination currency notes could become a political liability. Many political pundits believe that one of the reasons for the defeat of the BJP in three heartland states of Chhattisgarh, Madhya Pradesh and Rajasthan in December 2018 was the adverse impact of demonetization on small businesses and farmers. It was argued that voters felt the impact of demonetization, not immediately, but after about a year or so. Hence, the Assembly elections in UP in early 2017 were won by the BJP under the aura of demonetization, but as time wore on, winning elections became difficult for the BJP, with the spectre of demonetization hanging over its head. Gujarat was a narrow victory for the BJP and Karnataka could not be won. And by December 2018, the BJP faced its biggest electoral setback. There were many other reasons for the BJP’s poor showing at the hustings in 2018, but the impact of demonetization on the economy with a time lag was certainly one of them.

  The lessons of demonetization have been so stark that it is unlikely that it would ever be repeated by any other leader in India. Arguably, demonetization changed the course of the Modi government’s track record. Till demonetization happened, the Modi government was having a smooth run, reviving the economy and the Modi juggernaut looked unstoppable in the political sphere. But after demonetization, the economic as well as political narrative of the Modi government changed and the challenges became more formidable and worrying. This is one decision of the Modi government, whose consequences for the economy and politics were so disruptive, that there is virtually no possibility of such an experiment being repeated for any government in the near future.

  Section 13

  GST: Widening the Tax Net

  CHAPTER 24

  ONE COUNTRY, ONE TAX

  It took almost a decade of planning before India could introduce what is arguably its biggest and also the most disruptive tax reform in the country—the GST. The goal of a ‘one country, one tax’ must have been tempting for all finance ministers.

  The realization of that goal required work and preparatory steps from governments ruled by different political parties. It was yet another example of key economic reform issues in the country seeing broad consensus cutting across political party lines. The first time the GST entered the government’s official agenda was in the Budget speech for 2006–07, presented by the then finance minister, P. Chidambaram. On 28 February 2006, he said:

  It is my sense that there is a large consensus that the country should move towards a national level Goods and Services Tax (GST) that should be shared between the Centre and the States. I propose that we set April 1, 2010 as the date for introducing GST. World over, goods and services attract the same rate of tax. That is the foundation of a GST. People must get used to the idea of a GST. Hence, we must progressively converge the services tax rate and the CENVAT rate. I propose to take one step this year and increase the service tax rate from 10 per cent to 12 per cent. Let me hasten to add that since service tax paid can be credited against service tax payable or excise duty payable, the net impact will be very small.

  That bold statement also reflected the flawed political understanding of the idea of the GST. The world over, the GST rates for essential goods are often different from those for services. A classic example is food items, which are often zero-rated, but restaurant services are taxed at a different rate.

  But the more pertinent question that statement triggered was why Chidambaram was so confident that he would be able to launch the GST in about four years? Even the launch of the state-level value-added tax (VAT) system took more than a decade before it could be launched in April 2005. The state VAT system was far less complicated than the GST, which would have required an amendment to the Indian Constitution. Perhaps the fact that the state VAT system was launched just about a year ago and that it had been accepted by most states might have enthused Chidambaram to ride on it and launch the GST in the next four years. To be fair, while announcing the 2010 deadline for the launch of the GST, Chidambaram had already set the ball rolling as far as converging the duty rates on goods and services was concerned. His Budget for 2006–07 had raised the service tax rate from 10 to 12 per cent, so that reaching a desirable mean rate of 16 per cent (which was also the standard rate for goods excise at that time) would be feasible over a period of four years.

  The idea of a state-level VAT was discussed at the official level for the first time when Manmohan Singh was the Union finance minister. He convened a meeting of all state chief ministers in 1995 and discussed the need for a VAT to replace the sales tax regime followed by different states. The Indian Constitution mandated that while the Centre could levy excise on manufacturing, the states had the exclusive right to impose sales tax—a levy at the point of sale. Such a sales tax regime, however, suffered from the problem of cascading of taxes. In other words, taxes would be paid at all points of sales and every sale would mean that the sales tax is paid over and above the various sales taxes paid at the earlier stages of the value chain or production. Such cascading of taxes was sought to be avoided through the introduction of a state VAT system by replacing the sales tax regime. In the state VAT system, the taxes paid during the various intermediate stages of production would be adjusted against the final tax paid at the last point of sale, resulting in either a set-off or a refund of excess taxes paid.

  The advantages of a state-level VAT in lieu of sales tax were many. The state VAT would have far fewer tax rates and the taxes paid at the intermediate stages of production would be set off in the form of input tax credits. In subsequent years, follow-up meetings with state finance ministers on the advisability of introducing state VAT were held under different governments and a decisive stage was reached in 1999 when Finance Minister Yashwant Sinha under the Atal Bihari Vajpayee-led government held a meeting of state chief ministers.

  Two broad decisions were taken by Sinha. One, the states had committed themselves to not engaging in a rate war among themselves and ensuring uniform rates for different commodities. This was a major concession granted by the states, which have historically tried to attract investments by offering lower taxes or specific tax exemptions. States like Maharashtra, Tamil Nadu, Karnataka and Gujarat have benefitted by offering these tax incentives. With the states giving such commitment now, they denied themselves the option of wooing investment through tax incentives. All that they could do to attract industries would be to promise better infrastructure and easier procedures to improve the ease of doing business. Two, there was a general agreement among all the states that they would have to discontinue the various sales tax incentive schemes that essentially offered exemptions and concessions under various circumstances. At that meeting, the expectation was that the state VAT regime could be launched from 2001.

  However, delays began dogging the process as the Vajpayee government set up an Empowered Committee of State Finance Ministers to prepare the format for the new tax regime. Headed by West Bengal Finance Minister A
sim Kumar Dasgupta, the Committee took its own time but eventually agreed on having a VAT framework which should have common features across all the states. At the meeting of the Empowered Committee of State Finance Ministers held in January 2002, it was decided that the new regime could be launched from 1 April 2003. But this deadline too was missed, except for Haryana which went ahead with the agreed VAT regime on the agreed date. Other states joined Haryana two years later only after the general elections were held in 2004 and a new government at the Centre was in place, with Manmohan Singh as the prime minister and Chidambaram as the finance minister. That seemed to have augured well for the state VAT regime, as it could be finally launched from 1 April 2005. The Union government had guaranteed all the states that if there was a revenue loss for them as a result of the introduction of the state VAT regime, the Centre would compensate them for a specified period of three years. Over the years, the compensation demands were relatively small and the states’ revenues actually increased significantly in the subsequent years.

  Did the state VAT regime get implemented as was planned? Not really. Taxation expert Satya Poddar vividly recalls that the key agreement among the states on not competing through tax incentives was violated at least in spirit, if not in letter. The form of tax incentives changed as they resurfaced in the guise of deferred tax payments. A deferral of tax payment essentially meant that the industries could collect the VAT, but need not deposit it with the state governments and keep it with themselves for a specified period of time. This amounted to be an interest-free loan to the industries—a tax incentive, but in a disguised form. Economist and fiscal policy expert Raja J. Chelliah had moaned many years ago that tax incentives were a race to the bottom. That race continued somewhat even after the launch of the state VAT system.

  The idea of a VAT was quite old as it emanated from a committee that was set up in July 1976 under the chairmanship of Lakshmi Kant Jha, former governor of the RBI and a well-known economic administrator who had advised both Lal Bahadur Shastri and Indira Gandhi. Jha had recommended that in order to widen the tax base and improve tax mobilization it was necessary to move to an ad valorem tax system, where the tax rate was not a specific amount linked to the physical quantity of the product but would be levied as a percentage of its value. Thus, a product like the passenger car would attract an ad valorem rate of say 30 per cent. Every time the pre-tax price of the car would go up, the tax amount would also increase since that is levied as a per cent of the price of the car. But crude oil or petrol would attract a specific rate of duty, where the duty would be expressed as a specific amount to be levied per litre of oil. In the specific tax regime, even when the basic pre-tax price of the product goes up, the incidence of taxation does not go up automatically. Thus, an ad valorem taxation system has a built-in revenue buoyancy due to inflation and any increase in product prices. This concept was further refined and a modified VAT (Modvat) system was introduced by the then finance minister, Vishwanath Pratap Singh, in 1986. The coverage of Modvat initially was very limited, but the system allowed manufacturers to recover the taxes they paid on specified raw materials and components. Thus, under the Modvat system, a manufacturer of a product would pay the excise at the factory gate at a specified rate, but its incidence would be less as he would be availing the set-off benefits by way of credits against the taxes he may have paid on the inputs used by him in producing the final goods.

  This process was expedited as the tax reforms committee, headed by eminent economist and fiscal policy expert Raja J. Chelliah, had also endorsed the idea of a VAT system in its reports in the early 1990s. Successive governments heeded these recommendations and expanded the scope and coverage of Modvat. Even in respect of the GST, it was Chelliah who led the critical thinking behind the idea of such a VAT system. The Tax Reforms Committee, headed by Chelliah, had recommended the levy of a service tax to broaden the indirect tax base. In his Budget for 1994–95, Finance Minister Manmohan Singh noted that even though services accounted for about 40 per cent of the country’s GDP, they did not attract any taxes. He made a beginning by levying a 5 per cent service tax on the amount of telephone bills, the net premium charged by insurance companies and the commission charged by stockbrokers. Over the years, the number of services covered under the service tax rose to 119 by 2012, when a negative list was introduced. This meant all services barring the seventeen in the negative list attracted service tax. The introduction of service tax was significant as it created a base for healthy revenue source and paved the way for further reforms in the indirect taxation system, eventually leading to the introduction of the GST. First came the Cenvat and then its combination with the service tax resulted in the GST. What remained to be done was to frame the modalities.

  Around the time the service tax was introduced, another big push towards the GST came from a 1994 report from the National Institute of Public Finance and Policy (NIPFP)—‘Reform of Domestic Trade Taxes in India: Issues and Options’.1 The task was undertaken at the instance of the finance ministry at the Centre, which wanted a design of ‘possible system of Value Added Tax for India on which there could be a broad agreement among the Centre and the States’. The study team that worked on the report was led by NIPFP director Amaresh Bagchi, with assistance from four experts from the NIPFP, an IAS official from the government of Maharashtra and two international taxation experts—Satya N. Poddar, who was with Ernst & Young, Toronto, and Sibren Cnossen from Erasmus University, Rotterdam. The NIPFP report eventually would become the blueprint for both the state VAT system and the GST in India. One of the key recommendations of the report was that ‘in exploring the possibilities of introducing VAT in India, one has to think of a dual system in which both the Centre and the States share the consumption tax base in a mutually acceptable arrangement’.2 The GST that was launched in India from 1 July 2017 followed the dual model, thus becoming only the second country after Canada to adopt a similar system.

  While discussion on a VAT system continued within the government on the basis of the NIPFP report of 1994, the government of Atal Bihari Vajpayee introduced the Central Value Added Tax (Cenvat) in 2002 to replace Modvat. The then finance minister, Yashwant Sinha, made sure that there were only three rates under Cenvat—a merit rate of 8 per cent for items of necessity for the common man, a demerit rate of 24 per cent for luxury or sin goods, like high-end vehicles, tobacco or alcohol and a mean rate of 16 per cent for the remaining items. At that time, the goods under 16 per cent, or the standard rate, accounted for almost 90 per cent of the government’s total indirect tax revenues. The ultimate and ideal goal was to bring together all the rates to a single Cenvat rate.

  Even before the launch of Cenvat, Vajpayee had taken a decision in 2000 that will have a far-reaching impact on the future of the GST. This led to the setting up of a committee, whose brief was to design a framework for a GST to be introduced in the entire country. Significantly, Vajpayee invited West Bengal Finance Minister Asim Kumar Dasgupta to head this committee. Seeds of a country-wide political consensus on the need for a GST were sown at that stage. Dasgupta was a member of the council of ministers of a state that was ruled by the Left Front, no ally or friend of the BJP or Vajpayee. Not only did Vajpayee realize that getting a finance minister of a Left Front-ruled state would help achieve political consensus, but even the West Bengal government’s Left leaders allowed its finance minister to launch this initiative in the larger interest of the country.

  Three years later, Vajpayee decided to set up a task force under the leadership of Vijay L. Kelkar, an economist who served the government in various capacities including as finance secretary in the Vajpayee government, to recommend tax reforms. A year later, after the Manmohan Singh government was formed and Chidambaram was at the helm in North Block, Kelkar, who continued to function as an adviser to the finance minister, recommended that the time was ripe for replacing the existing indirect tax regime with the GST. Kelkar largely adhered to the Bagchi model outlined in the 1994 NIPFP repor
t and suggested that the new regime should have a dual GST structure, with a central GST of 12 per cent and a state GST of 8 per cent.

  In a dual GST structure, there are two components of the overall duty rate. Any commodity or service will have these two rates combined into one. Ideally, the state rate is the same as the central rate. The state rate is levied in lieu of the various state-level taxes and the central rate is levied in lieu of the central excise and different types of cess. The overall GST rate is levied and collected through a centralized system and then shared between the Centre and the state where those goods or the services have been consumed. The GST is a destination-based tax and is levied at the point of consumption or use. But the duties collected are shared in accordance with a pre-determined formula between the Centre and the states. The central GST rate would replace the Cenvat rate levied by the Centre and the state GST would come in lieu of the VAT imposed by the states.

  Two years later, Chidambaram made his now-famous statement in his February 2006 Budget speech that set the first official deadline for the launch of the GST by April 2010, a deadline that would be shifted on two more occasions before the new tax regime would be finally rolled out after eleven years.

  The Failure of the UPA

  There was no dearth of political turns and twists impacting the GST during this period starting from 28 February 2006 to the midnight of 30 June 2017. Work for rolling out the GST began at a good pace.3 An empowered committee of state finance ministers was constituted and by November 2006 it discussed a report submitted by a working group it had set up. Even as this Committee under the chairmanship of the West Bengal Finance Minister Asim Kumar Dasgupta started meeting regularly, the terrorist attack in Mumbai on 26 November 2008 cast an indirect impact on the pace of progress on the GST front. In order to beef up the home ministry in the wake of the terrorist attack in Mumbai, Prime Minister Manmohan Singh shifted Chidambaram to the home ministry. The finance ministry was looked after by the prime minister himself as an additional charge till 24 January 2009, when Pranab Mukherjee was asked to take charge of North Block. By then, however, the government was preparing for the general elections to be held in May 2009 and GST ceased to be a priority even for the finance minister at least in the first half of that year. After the elections, the UPA was back at the helm and Mukherjee retained his finance portfolio to resume work on the GST. But a sense of unrealism was now noticeable as in spite of less than a year left for the deadline of April 2010, the newly elected government was still hopeful of meeting it. Only in the last week of February 2010, did it realize that the deadline would have to be deferred by a year.