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Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)

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 .....

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erge of implementing a GST. But now, with political consensus close to being secured, 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 mar .....

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ms-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 d .....

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a, Germany, Austria, Switzerland, etc. State government relieved of responsibility of raising taxes which also takes away fiscal discretion of States Dual VAT Canada and India today A combination of the above two and hence limits both their disadvantages Clean dual VAT India s GST Common base and common or similar rates facilitate administration and compliance, including for inter-state transactions, while continuing to provide some fiscal autonomy to States Source: World Bank (2015) 1.5 The Ind .....

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ible 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 ensu .....

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nt, in our view three benefits stand out in today s context: governance/institutional reform and Make in India by Making one India, which are two key pillars of the government s reform efforts. The investment, and hence growth, benefits could also be substantial. Governance 2.2 The government has placed a great deal of emphasis on curbing black money reflected in the Black Money Bill. These measures can be very significantly complemented by a GST, which, especially if it is extended to as many g .....

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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 Haughto .....

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e in audit, suggesting that being part of the VAT itself performs the self-auditing function (Pomeranz, 2013). Moreover, the study finds that increasing the audit probability of firms suspected of evasion generates spillovers up the VAT paper trail that lead to an increase of their suppliers' tax payments. In a sense, the supplier, because of the paper trail left by the VAT, knows that his evasion will be more likely to be detected once his client is audited. 2.6 Second, the GST will in effe .....

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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 p .....

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2.10 Consider a simple example, where intermediate goods produced in Maharashtra go to Andhra Pradesh for production of a final good which in turn is sold in Tamil Nadu. Effectively, the goods will face an additional tax of 4 per cent, which will reduce the competitiveness of the goods produced in Andhra Pradesh compared with goods that can be imported directly to say Chennai from South and East Asian sources. 2.11 How quantitatively significant is the impact of the CST? We have some suggestive .....

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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 .....

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ivalent to additional 164 kms per day -pulling India above global average and to the level of Brazil. So, logistics costs (broadly defined, and including firms estimates of lost sales) are higher than the wage bill or the cost of power, and 3-4 times the international benchmarks. 4 2.15 Another study shows that inter-state trade costs exceed intra-state trade costs by a factor of 7-16, thus pointing to clear existence of border barriers to inter-state movement of goods. Further, inter-state trad .....

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igh (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 .....

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ving neutrality of incentives between domestic production and imports requires that all domestic indirect taxes also be levied on imports. So, if a country levies a sales tax, VAT, or excise or GST on domestic sales/production, it should also be levied on imports. In India, this is achieved through the CVD/SAD which is levied on imports to offset the impact of the excise duty levied on domestically manufactured goods. 2.20 However, CVD/SAD exemptions act perversely to favour foreign production o .....

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ut 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 .....

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whole range of imports. These exemptions can be quantified. The effective rate of excise on domestically-produced non-oil goods is about 9 per cent. The effective collection rate of CVDs should theoretically be the same but is in actual fact only about 6 per cent. The difference not only represents the fiscal cost to the government of ₹ 40,000 crore, it also represents the negative protection in favour of foreign produced goods over domestically produced goods. 2.22 Two defenses of CVD exe .....

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c 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 eliminat .....

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situation should be an exemptions-free regime. If particular sectors seek relief from the CVD/SAD, they should be required to make their case at the appropriate forums. 2.26 In a sense, India finds itself in a de facto state of negative protection on the one hand, and calls for higher tariffs on the other. It is win-win to resist these calls that would burnish India s openness credentials and instead eliminate the unnecessary and costly penalty on domestic producers. 2.27 All these three sets o .....

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rgence 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 inpu .....

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stment in a given year suffers from noncredtable excise duties and/or VAT. For example, indirect tax collection data for 2014-15 indicate that the total amount of capital goods purchases for which CENVAT credit was claimed was ₹ 1.6 lakh crore, divided between goods (Rs. 1 lakh crore) and services (Rs. 0.6 lakh crore). National income accounts data suggests that investment in plant and equipment for the same year by the non-government, non-household sector was about ₹ 7.4 lakh crore. .....

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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 al .....

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es the cost of capital goods and reduces investment, which in turn leads to lower employment and output. III. CURRENT STRUCTURE OF INDIRECT TAXES: HIGHLIGHTS 3.1 This section describes briefly the structure of current rates of domestic indirect taxes at the Centre and the States. The key takeaways are that the current tax structure is highly complex, highly leaky (riddled with exemptions in goods that we estimate to be about 2.7 per cent of GDP for the Centre and States together) characterized b .....

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licated 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 .....

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tainty in the base, and specifically being unable to distinguish goods from services. The exemptions threshold is ₹ 10 lakh. 3.5 At the Centre, there is incomplete provision of input tax crediting for goods, and incomplete cross-crediting between goods and services. States 3.6 In relation to goods, the States have structures characterized by: a base that is complete in extending all the way to the retail stage an exemptions threshold that varies across States between 5 and 10 lakh with a p .....

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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 .....

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he RNR which are described in detail in Annexes 1-3. These will constitute the basis for the Committee s recommendations on the RNR.11 These are briefly summarised in this section. 4.2 Before describing the recommendations, it is important to make a point relating to terminology. Throughout this report, the term 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 preci .....

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ich 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 revenue .....

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or 29 States and 2 UTs. What all the RNR exercises attempt to do is to calculate B, the total tax base for generating the required GST revenues. The three approaches presented to the Committee can be called, respectively, the macro, the indirect tax turnover (ITT), and the direct tax turnover (DTT) based approaches. Macro approach 4.4 The macro approach-presented by the staff of the International Monetary Fund-makes use of national income accounts data and supply-use tables to arrive at the base .....

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ctors, 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 b .....

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cent (0.061/.55). 4.6 Losses in the order of 10 to 20 per cent of potential revenues are common in OECD countries; assuming 20 per cent increases the range of the RNR from 9-11 per cent to 11-14 per cent. 4.7 In summary, this analysis suggests that the GST RNR rate ranges between 11 to 14 per cent, depending on key policy choices regarding exemptions. The scenario that corresponds closest to the proposed Constitutional Amendment bill yields an RNR of 11.6 percent after factoring in a compliance .....

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l 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 la .....

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f ₹ 8.5 lakh crore and a combined base (goods and services) of ₹ 39.4 lakh crore. 4.11 This base, in turn yields a single RNR of 17.69 per cent under the scenario of having to compensate the States for the 2 per cent CST. The corresponding standard rate under current structures of taxation is estimated at 22.76 per cent. It is worth recalling that an earlier analysis based on the same methodology by NIPFP was presented to the Empowered Committee of the GST in February 2014. That anal .....

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lculated. 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 (petroleu .....

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s. 183 lakh crore) and capital goods (Rs. 6 lakh crore). The latter include purchases by exempt sectors (Rs. 25 lakh crore), purchases of primary goods (Rs. 11 lakh crore) and purchases from unregistered dealers ₹ 24 lakh crore). This yields an input tax base of ₹ 130 lakh crore. 4.15 Further adjustments are made to take account of the value added of firms that will fall below the exemptions threshold (removed from the taxable base); of the alcohol sector (removed from the taxable ba .....

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= 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 t .....

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very choice of rates could affect the outcome relating to revenues, compliance, convenience, etc. 5.3 We will make our recommendations in two steps. First, we will critically evaluate each of the three approaches both in terms of the methodology and in terms of the results they generate for the RNR. We then present the Committee s recommendations for the RNR and validate these results against independent benchmarks. These recommendations will be supported by a complementary discussion on the ri .....

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ed 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 .....

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Pradesh, West Bengal, Haryana and Puducherry) that together account for about 78.5 per cent of all States VAT base. These data vary significantly from the assumptions underlying the ITT approach. Specifically, our data suggest that the aggregate base is distributed between the three different rates-1 per cent, 2-6 per cent, 12-15 per cent and higher rate-in the ratio of 11.6 per cent, 55.4 per cent, 28.5 per cent and 4.7 per cent. In contrast, the ITT assumed-without analysing actual data-tax b .....

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mportant 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 t .....

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r withholding type effect would come into play with the elimination of all CVD exemptions which the ITT approach does not fully take into account.14 v. The ITT approach also does not fully incorporate into the base, sugar products and textiles15 that are sold directly to the consumer.16 5.8 The DTT approach on the other hand is subject to two uncertainties: whether the output tax base has sufficiently taken account of exempted sectors, and whether the estimates of purchases from the unorganized .....

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s 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 complianc .....

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he base. Then, we add an adjustment for compliance efficiency gains (Rs. 2 lakh crore). 5.13 What is the basis for these adjustments? 5.14 Note that the ITT approach was based on a pure assumption about the States VAT base which we have improved upon by collecting the relevant data for 16 States, accounting 78.5 per cent of the entire VAT base of the states. 5.15 The adjustment for sugar is based on the national income estimate for value-added in the sugar sector of ₹ 40,000 crore. We cons .....

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f 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 .....

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er consulting with the CBEC, that just under half of this compliance improvement (Rs. 2 lakh crore) would be realized. 5.19 To summarize, our adjustments to the ITT approach are conservative in the following ways: We do not make any adjustments for the ITT approach understating the contribution of textiles to the tax base which could be substantial. The magnitude of this omission is suggested by the fact that the gross value of output and gross value added of textiles and cotton ginning are 5.9 .....

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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 d .....

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nts in efficiency. These are not improvements that will take years to materialize. 5.22 Adding up these adjustments yields a single RNR of 15 per cent. However, we recognize that there may be uncertainty about the adjustments we have made. An alternative scenario is that not all of the adjustments are valid. In this case, the single RNR would be 15.5 percent (Table 6). Table 6: Committee s recommendations compared with other approaches to estimating RNR Approach GST Base (in lakh crore) RNR (per .....

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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 tha .....

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mplied by the macro and DDT estimates for the RNR (of 0.70 and 0.68 respectively) would place India above other emerging market countries. In contrast, the c-efficiency implied by the ITT approach of 0.40 would put India well below the average of emerging market countries and only somewhat above that for low-income countries. 5.26 Put differently, if the RNR, and the associated standard rate, of the ITT approach were reasonably estimated, it would imply that India has either come up with an effe .....

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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 s .....

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ult in a standard rate of about 19-21 per cent which would make India an outlier amongst comparable emerging economies. For example, the ITT approach s RNR of 17.7 per cent would translate into a standard rate of 22.8 per cent, identifying India as having the highest GST tax rate amongst emerging market economies. Our recommendations would still place India at the upper end of the standard rates found across comparable countries. It is worth emphasizing that the GST is intrinsically a regressive .....

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R 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, compensat .....

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d even afford to relax its deficit target, based on the fact that was actually an investment for implementing unprecedentedly ambitious tax reform with enormous long-run gains; moreover, a moderately higher deficit due to a low GST will benefit consumers, especially poorer ones. 5.34 Second, given the unavoidable teething troubles that will afflict GST implementation, it seems inadvisable to further burden the initial stages of implementation with higher rates that will increase taxpayer displea .....

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s. 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 .....

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er cent with the Swacch Bharat cess). If the RNR is greater than 15-15.5 per cent, the rate for services will be in the 20-22 percent range which will make the GST seem like a substantial tax increase when it strictly speaking is not and should not (after all, the new rate should be revenue neutral). Optically, the GST as a rate hike should be avoided to the greatest extent possible. A lower rate will be seen as more politically acceptable and will help taxpayer compliance. 5.38 Fifth, even if t .....

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pensation 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 .....

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tes Exemptions 5.40 Given the historic opportunity afforded by the GST, the aim should be to clean up an Indian tax system that has effectively become an exemptions raj with serious consequences for revenues but also governance. According to the government s own figures, excise tax exemptions (and taxing goods at low rates) result in foregone revenues of ₹ 1.8 lakh crore or nearly 80 per cent of actual collections. Tentative estimates by the Committee suggest that the comparable figure for .....

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ood 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 sma .....

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ed to a few goods, that are merit goods which feature prominently in the consumption basket of the poor such as food items (see Box 3 for a detailed analysis of which items deserve exemption status); Exemptions should also be confined to final goods because taxes on intermediates are in any case reclaimable as input credits;21 Exemptions must be common across the Centre and States; Precious metals not be exempted to the extent they are for reasons described below; Area-based and CVD exemptions b .....

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n 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 = &alph .....

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and services, obviating the need for defining goods and services separately. Thus: SG = SS = (R - αLG - μDG) / (β + γ) 5.48 The next point to note is that for any given RNR (that has been estimated), and a given higher rate (discussed below), the lower is the lower rate, the higher will be the standard rate. 5.49 Ideally, the lower rate should not be far lower than the RNR for two reasons. The lower the rate and the more the commodities that are taxed at this lower rate, the .....

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creases 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 A .....

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lows in table 7. 5.53 To illustrate the impact of policy choices on the standard rate, we present in Table 7, the consequences for the standard rate (for the given RNR of 15 per cent) of the treatment of gold and precious metals (for details on the tax treatment of these commodities, see Box 3). As the table shows, the lower the rate that these commodities are taxed, the higher will be the standard rate that is applied to all commodities. For example, if gold is taxed at 4 percent the standard r .....

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d 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 .....

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ST Council. 5.55 We recommend one demerit rate and that rate should be such that the current revenues from that high rate are preserved. Accordingly, we recommend 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 Centre can, of course, levy an additional excise on tobacco and tobacco products over and above this high rate. These goods are final consumer good .....

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cally 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 als .....

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, say the bottom four deciles of the population.23 The subsidy essentially measures how much the expenditure of the target group would be increased by exempting a good rather than taxing it at the standard rate. 5.59 The cost could be measured in relation to the principle of effective targeting. The cost is simply that proportion of the total subsidy for any particular good that does not reach the target group and instead leaks to the non-target group, in this case, the top 6 deciles. 5.60 When .....

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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 activel .....

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city are also not appropriately treated. They are all commodities that prima facie seem to be merit goods, warranting zero or low tax burdens. However, in India, they are mostly consumed by the rich, and many are largely privately provided. In the case of education, the current tax structure turns out also to be regressive, with the bottom 4 deciles effectively paying greater taxes than the top 6 deciles They deserve to be taxed more like standard goods. Yet, most education and health services w .....

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ate 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 .....

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ed Current Proposed under GST Goods Services Compounding Goods plus Services Compounding Center 1.5 crore; exports and exempted goods excluded from threshold 10 lakh not permissible 25 lakh combined with no exemptions and aggregated at the level of legal entity to be decided; but possibility of compounding from exemptions threshold (25 lakh) up to 1 crore States 5-10 lakh not applicable permissible in some States for some items and at varying rates same as above same as above Source: Department .....

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d. 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 T .....

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l States indirect tax revenue and about 41.8 per cent of the total revenue of States to be subsumed under GST-as well as power, real estate, health and education remain outside the scope of the GST. Even if petroleum, alcohol and tobacco are subsumed in the GST, States will retain the right to levy top-up excises on them. 5.66 In other words, the design of the GST is such that states will continue to have considerable autonomy under the proposed GST either in its current form (which has a number .....

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nd 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 woul .....

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s of commodities in the consumption basket (on which the CPI is based) are different from their contribution to indirect tax collections. The impact on particular goods and services will depend on the current structure of taxation (including exemptions) and the future structure of the GST both at the Center and the states. To estimate the impact on future inflation, we need to begin with understanding the current structure of taxes. Current taxes on the consumption basket 5.70 The average effect .....

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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 som .....

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les and fruits is 0.5%, but adjusted for the taxes paid on inputs, the effective tax rate on cereals and vegetables rises to 4.8% and 1.1% respectively. The same holds true for electricity: this is not taxed explicitly, but the effective tax rate is 8.8%. Even after these adjustments however, these effective rates are low. Further, to some extent, even these numbers do not truly reflect the net tax burden because of the subsidies provided by the public distribution system (PDS) as described belo .....

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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 .....

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er spend for the top 60%. 5.78 For clothing the average tax rates are relatively similar-about 9 %-between the two groups, and across states. In fuel and light, overall taxes are progressive but because electricity comprises a higher share of consumption of the top 60%, the exemption given to electricity benefits the top 60% more than the bottom 40%. The price impact of the GST Regime 5.79 We analyse scenarios for both a single rate (of 14%) and two scenarios involving a dual rate GST (12% and 1 .....

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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 eac .....

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ducers may still price on the headline rate. 5.83 We have also not factored in producers pricing power in assessing the impact on inflation: some may not have the pricing power to take price increases (e.g. prices that are determined globally, say a cotton farmer that sees an increase in input prices), while others, like producers of personal products, may not cut prices even if they see a reduction in their tax rates. 5.84 Single-rate GST: The higher the single rate, the greater the price impac .....

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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 sensitivi .....

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of about 17-18%. The inflation impact in this scenario lies in between the first and second scenarios: a 22% standard rate would drive a CPI increase of 0.3% if all producers reacted to headline tax changes and by 0.7% if they adjusted for input taxes: the increase is a reflection of hidden taxation, i.e. the headline taxes may be low, but an increase in input taxes would raise inflation. Health (excluding medicines) would see the highest increases (Figure 14). Concluding observations 5.89 The e .....

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e 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 synchroniz .....

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ice tax, collections would be ₹ 5000-plus crore, but the collections are about ₹ 100 crore); d) How many suppliers react just to the headline rate and have the pricing power to either take price increases or hold on to prices even when they are net beneficiaries of GST implementation; e) Given the large impact of PDS on food and fuel and light, the impact on the bottom 40% can be offset by state governments making changes to the PDS. f) New GST features: currently excise and VAT cann .....

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avior 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 shor .....

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may have to decide to raise rates going forward but interim shortfalls will have to be compensated. 5.95 A more likely scenario is for shortfalls to be experienced by individual States even if States as a whole experience revenue neutrality. Now, by definition, the move from the status quo to the GST will involve a shift in revenues from producing States to consuming States, from manufacturing to services, and within manufacturing from intermediate and capital goods toward final goods. This dis .....

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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 .....

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forward. 5.98 Notwithstanding the above, there need to be clear rules on compensation to avoid glitches and controversy in the implementation of GST and to reassure the States so that they too can embark on GST implementation with enthusiasm and confidence. 5.99 Compensation will have to be provided for the shortfall between the actual level of collection (RA) in any particular year and the collection level to be protected (RP) in that year. The challenge will be in identifying the latter. 5.100 .....

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ccordingly. 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 Lo .....

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d be normal and which should not be attributed to the GST and hence would not necessarily need to be compensated. 5.103 Hence, the formula for GST compensation going forward would have to take account of two factors: on the one hand, erring on the side of generous compensation would provide reassurance and certainty to the States on revenue availability and help them better plan their expenditures; on the other hand, the formula should take account of the dramatically changed outlook for nominal .....

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t 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 .....

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fiscal autonomy in this area. 5.107 The same applies to real estate which is also a major arena of rent-seeking. Bringing electricity into the GST could also improve the competitiveness of Indian manufacturing. And, as argued in detail in Box 3, reducing the exemptions on health and education services in the GST would be more consistent with social policy objectives than the status quo. VI. CONCLUSIONS 6.1 This is a historic opportunity for India to implement a game-changing tax reform. Domesti .....

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th 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 r .....

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es to charge at a lower rate (if at all), and what to charge at a very high rate. The RNR should be distinguished from the standard rate defined as that rate in a GST regime which is applied to all goods and services whose taxation is not explicitly specified. Typically, the majority of the base (i.e., majority of goods and services) will be taxed at the standard rate, although this is not always true, and indeed it is not true for the states under the current regime. 6.5 Against this background .....

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e 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 cente .....

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to facilitating compliance and administration, India should strive toward a one-rate structure as the medium-term goal. Meanwhile, we recommend a three-rate structure. In order to ensure that the standard rate is kept close to the RNR, the maximum possible tax base should be taxed at the standard rate. The Committee would recommend that lower rates be kept around 12 per cent (Centre plus states) with standard rates varying between 17 and 18 per cent. It is now growing international practice to .....

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ithin 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 selectivi .....

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d distortionary. A rationalization of exemptions under the GST will complement a similar effort already announced for corporate taxes, making for a much cleaner overall tax system. The rationalization of exemptions is especially salient for the center, where exemptions have proliferated. Indeed, revenue neutrality for the center can only be achieved if the base for the center is similar to that of the states (which have fewer exemptions-90 products versus 300 for the center). If policy objective .....

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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 .....

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between the Centre and states; The GST also represents a historic opportunity to Make in India by Making One India. Eliminating all taxes on inter-state trade (including the 1 percent additional duty) and replacing them by one GST will be critical to achieving this objective; Analysis in the report suggests that the proposed structure of tax rates will have minimal inflationary consequences. But careful monitoring and review will be necessary to ensure that implementing the GST does not create t .....

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litating 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 .....

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black money generation without compromising on states fiscal autonomy. Bringing electricity and petroleum within the scope of the GST could make Indian manufacturing more competitive; and eliminating the exemptions on health and education would make tax policy more consistent with social policy objectives. 6.6 There is a legitimate concern that policy should not be changed easily to suit short term ends. But there are enough checks and balances in the parliamentary system and enough pressures of .....

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tting 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 indepe .....

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portunity. Box 1. Estimating the association between rates and compliance Many considerations will go into the determination of the revenue neutral rate, but one of them will also be the impact of rates on compliance. Theory suggests that increases in rates will lead to reduced tax compliance. But is there any evidence from the experience of VAT itself? Based on data provided by the IMF, the Committee undertook a simple econometric analysis to test whether tax rates and compliance were correlate .....

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ial. 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 cou .....

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n the standard rate worsens compliance by 1.22 percentage points.27 This has an important implication for the RNR in India. It suggests that a lower RNR will not lead to as much of a loss in revenue as a simple calculation suggests. For example, if the standard rate were reduced by say 4.1 percentage points in weighted terms that should increase C-efficiency by 4.1 percentage points (using the conservative regression estimate of 1 rather than 1.22) which amounts to about 9.3 per cent given the c .....

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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 Requiremen .....

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m estimating state-specific RNRs. But we can shed some light on this question by looking at proxies for the likely future tax base of States. This future tax base will be based on consumption rather than production. So, we need to find proxies for the States share in consumption of taxable goods and taxable services. We turn to the NSS-which measures consumption-to calculate taxable goods consumption. We define each state s share in taxable consumption of goods as SG i where G the superscript re .....

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atter 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 &alp .....

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shows points on the line where the current and future tax base are likely to be the same. All points above the line denote States that will potentially need to be compensated. The chart has two interesting and potentially significant implications for compensations: First, most of the points are below or close to the 45 degree line, and where they are above the line, they are not very far above it. This suggests that on aggregate there will not be a huge re-shuffling of taxable revenues Second, .....

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ns 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 .....

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expenditures of poorer households-for example, food-will either be exempt or placed in a lower rate category. But these decisions have to be underpinned by analysis and evidence. This section undertakes such an analysis and then compares the outcome of this analysis with current policy. In other words, the question is whether current tax policy is consistent with social objectives in relation to a number of key commodity groups: Food and beverages (and sub-groups) Clothing Fuel and light (exclu .....

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sions 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 t .....

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an 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 group, say the bottom four deciles of the population.30 The subsidy essentially measures how much the expenditure of the target group would be increased by exempting a good rather than taxing it at the standard rate. The cost could be measured in relation to the principle of effective targeting. The cost is simply that proportion of the total s .....

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ffective 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, .....

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erhaps clothing.31 The data that underlie this graph are presented in Table 1 for the commodities of policy interest. In each table, the share of each commodity in total expenditure of the target group (bottom 40 percent, B40) and the non-target group (the top 60 percent, T60) is presented. This is a measure of equity. The table 1 also presents the share of the total expenditure on a commodity group that is accounted for by the target and non-target groups. This provides a measure of effectivene .....

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ts 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 .....

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enefit cost ratio, the lower should be the tax. The line of best fit is downward sloping, indicating that tax policy is broadly sensible. Food, fuel, and clothing A number of commodities are treated fairly under the current system. Thus, merit goods such as food items, especially cereals, pulses, edible oils, vegetables, and fuel are appropriately taxed at zero or low rates. Conversely, a number of demerit goods such as alcohol and tobacco are appropriately taxed at high rates. In the case of fo .....

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e 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 .....

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ghlights how ineffective or unfair is the implicit gold subsidy. It shows the expenditure of these commodities of each decile as a share of total gold expenditures. The top decile accounts for over 63 per cent of total gold expenditure. And this is a serious under-estimate because we know that NSS is very ineffective at capturing the expenditure of the very rich. Cumulatively, the top 2-3 deciles account for an overwhelming share of total gold consumption and therefore appropriate nearly all the .....

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er 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 neu .....

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own in Table 8, the standard rate could come down to as much as 16.8 per cent if gold is taxed at 12 (6+6) per cent. There might be concerns that increasing taxes on gold will lead to increased smuggling and evasion. This is a legitimate concern. But there is some evidence on how serious the impact of increased taxes might be. Import duties have been increased several times in the recent past on gold. These too are tax increases. In Figure 4 below, we plot the imports of official gold since 2011 .....

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lude 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, .....

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e case of education, the current tax structure turns out also to be regressive, with the bottom 4 deciles effectively paying greater taxes than the top 6 deciles. These commodities deserve to be taxed more like standard goods. Yet, today, they face low taxes and they are planned to be excluded from the GST. Thus, tax policy in the name of the poor turns out to be poor or ineffective social policy. And the cost is a tax base that is narrow, exemptions-ridden, and in the case of power, the cost al .....

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emplated 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 r .....

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lace with the GST. Assuming that R is known, policy decisions on the GST base become the Centre of policy discussions and design, and are intimately linked to the estimation of the RNR. National accounts data on final consumption, or supply and use tables can be used to estimate the equation above. They should yield similar results, but the latter provides more insight into how the GST is likely to affect various sectors of the economy, and is particularly relevant, if not necessary, when exempt .....

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ons, 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. T .....

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ntage is that sectoral analysis using national accounts data is usually limited, relative to firm-level data-where, for example, mixed supplies such as taxed/exempt by the same firm can be analyzed more effectively. As noted above, estimating the RNR requires clarity on policies regarding the revenues to be subsumed by the GST and the GST base; but these are still the subject of some debate, and are likely to remain until late in the policy process. A useful analysis then consists in examining t .....

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inal 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 additi .....

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factor to consider. Although the design of the GST is likely to improve compliance-even assuming no changes in administration, the federal/state coordination of the GST will improve information for cross-verification, especially regarding inter-state transactions-experience suggests that some losses to poor compliance and enforcement should be expected. Losses in the order of 10 to 20 of potential revenues are common in OECD countries; assuming 20 increases the range of the RNR from 9-11 to 11- .....

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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 &am .....

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tions from individual States, the tax rates applicable in these States and some assumptions based on discussions with States regarding the composition of turnover taxable by the 1 per cent rate, the lower rate and the standard rate. The assumptions adopted are 2 per cent of total base taxable at 1 per cent, 56.15 per cent taxable at the lower rate and the rest taxable at the standard rate. For each state, taxes have been classified into two groups - taxes, the base of which can be added to the t .....

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ties 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 n .....

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3672 1913 2441 2675 60701 b) Tobacco products 14855 1319 528 1153 17855 44637.5 Total CE duty {Non Pol} [a)+b)] 68527 3232 2969 3828 78556 2 CVD (Non-Pol) 77965 479 3663 883 82990 3 SAD (Non-Pol) 24837 0 0 0 24837 4 Service Tax 150417 0 4319 0 154736 5 TOTAL 321746 3711 10951 4711 341119 6 Total revenue to be compensated 327728 6i Non Tobacco revenues to be compensated 323264 6ii Tobacco products revenue at 10 per cent 4463.75 Note: * includes secondary and higher education cess. Source: Provide .....

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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 tha .....

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ison of MCA data 2011-12 2012-13 2013-14 Number of Firms 1. Firms with no valid code 34720 34059 21996 2. Firms not engaged in services 169042 175154 0 3. Firms in services 331124 356752 325013 4. Firms in service but not included due to coverage35 71813 76128 0 Total 606699 642093 347009 Turnover (Rs crore) 1. Firms with no valid code 1058035 22941162 730001 2. Firms not engaged in services 50129647 14171531 0 3. Firms in services 3062734 377877436 3412732 4. Firms in service but not included d .....

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g 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. .....

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rough assigning activity codes in 2012-13 1358755 5.Taxable turnover from step 4 (in 12-13 prices) 377204 6.Taxable turnover in 13-14 prices 405707 7.Total turnover from MCA after all corrections (2013-14) 4083607 This information relates to companies alone. Since the tax would be payable by non-corporate service providers as well, we have used information from service tax collection to correct any shortfall from the MCA related estimates. Further, for all the services, two kinds of adjustments .....

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s 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 s .....

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orresponding to the present service tax regime is considered a more appropriate base to incorporate into GST RNR estimation in both cases- PROWESS and MCA based estimates. Second, as per the input output table, more than 80 per cent of total financial services are used as inputs. But since a significant part of financial services are in the form of embedded services, the possibility of taking input tax credit can be limited. So using the ratio of FISIM to total financial services, the extent of .....

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n 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 & .....

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118838 Total 745390 Total after all corrections38 853235 The total base for GST from the above methods therefore can be summarised as; The RNR corresponding to the proposed design, with CST compensated at 2 per cent is summarised in the table below. The results presented contain four scenarios. The GST bill proposes that in the short term, the States would be enabled to levy a 1 per cent tax on inter-state sale of goods. Scenario 1 presents a case where there is no such levy while scenario 2 pr .....

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able 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 w .....

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les of transport vehicles is ₹ 717476 crore.39 Assuming that this part of the base is taxed at 15 per cent each by both Centre and States, the RNR got the rest of the base would be 6.81 per cent for the Centre, 8.09 per cent for the States adding up to 14.91 per cent overall as compared to 17.69 per cent reported above. To understand what these numbers indicate, it would be useful to look at the composition of the revenues from the States. The composition indicates that 19 per cent of the .....

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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 .....

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ng II 7.55 15.88 Effective tax rate for States 9.05 RNR for finding revenue for II as well 9.37 17. 69 Annex 3: Direct Tax Turnover Approach to Estimating RNR At the producer level, the GST base is equivalent to the value added which is the value that a producer adds to his raw materials or purchases before selling the new or improved product or service. That is, the inputs (the raw materials, transport, rent, advertising, and so on) are bought, people are paid wages to work on these inputs and, .....

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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 .....

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roducer level data in the form of profit and loss accounts available with the Income Tax Department. These accounts relate to 94, 31, 508 business entities for the financial year ending on 31st March, 2013 (financial year 2013-14)41. These entities comprise of all companies, partnership firms and proprietorships but do not include charitable organizations. The activities of these entities are classified into 10 sectors and further sub classified into 75 sub-sectors. We assume that these 94, 31, .....

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d 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 .....

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services . e. Under the GST Model, full and immediate input credit is proposed to be allowed for GST paid on purchase of capital goods in the year of purchase. Therefore, the value of purchase of capital goods is aggregated with the value of purchase of intermediate goods and services to arrive at gross value of purchase of intermediate goods and services . f. Since no input tax credit would be available in respect of purchases made from unregistered dealers, the value of purchases from the unre .....

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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) finan .....

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es as carrying on business or engaged in sales. Since all goods and services (except a small negative list) are proposed to be included in the GST base, the value of supply of goods and services must therefore, include the item other income . However, receipts by way of rent, dividend, interest, profit on sale of fixed assets, profit on sale of investment liable to STT, profit on other investment, profit on currency fluctuation and agricultural income have been excluded from the value of the sup .....

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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. The .....

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nput tax credit would be allowed since these goods would be exempt from GST. If for some reason, the agriculturist falls within the scope of the GST, he would be liable to collect GST for which the purchaser in our sample would be eligible to claim input credit. However, agriculturists do not ordinarily file an income tax return, and therefore, their sales do not form part of the output base estimated above. In either case, purchases of primary goods in this exercise would not be entitled to any .....

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ld 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 ava .....

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purchase of services from unregistered dealers is determined at ₹ 11, 26,059 crore. 12. Accordingly, the value of purchases from unregistered dealers in 2013-14 for taxable sectors is determined at ₹ 23, 12,560 crore. Since no input tax credit would be allowed on these purchases, the same is deducted from the value of purchases of intermediate goods and services for determining the GST base. 13 In the design of the GST, several exemptions are envisaged. In particular, these relate t .....

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e. 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 la .....

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kh accounting for a total turnover of ₹ 3,00,377 crore only. Effectively, 79 per cent of the total dealers accounting for approximately 1.35 per cent of the total turnover base will remain outside the GST net. Calculated on a pro-rata basis, the value addition by these dealers is estimated at ₹ 63,109 crore and the GST base is reduced accordingly. Table 2: Distribution across Turnover Corporate Non-Corporate Total Turnover Number of cases Total Turnover (in Rs. crs) Number of cases T .....

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tween ₹ 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 transportati .....

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377; 58, 15,262 crore. The implicit value addition is estimated to be 31 per cent of the total output tax base. Consequently, the RNR for the Centre and the State is estimated to be 5.64 per cent and 6.34 per cent, respectively. The combined RNR is determined at 11.98 per cent. Table 3: Estimate of RNR for GST: SI Method Unit Nos Amount A Sample Size 9431508 B Output Tax Base 1 Net value of supply of domestically produced goods and services Rs. In crs 22219783 2 Value of imports Rs. In crs 17444 .....

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e 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 S .....

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tax rate a. Output 13.5 8 b. Input 5 8 3 Base value of Inputs 60 60 4 UED on Inputs 7.2 4.8 5 Value of inputs for State VAT 67.2 60 6 Input VAT 3.36 4.8 7 Value Addition 32.8 32.8 We assume that the value addition is 32.8 8 Base value of Output (Row 3 + Row 7 ) 100 92.8 In the existing regime, the output is exempt and no input credit is allowed. UED on inputs become a cost for the taxpayer and therefore included as part of value addition. 9 UED on Output 0 7.42 The output is exempt and therefor .....

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e 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 .....

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, International Monetary Fund, WP/13/111, 2013. World Bank, Fiscal Policy for Equitable Growth, India Development Report, 2015. Pomeranz, Dina, No Taxation without Information: Deterrence and Self-Enforcement in the Value Added Tax, Harvard University and NBER, 2013. GTCDR South Asia, Republic of India Manufacturing Plan Implementation Supply Chain Delays and Uncertainty in India: The hidden constraint on manufacturing growth , 2014. Rao, Kavita, Revenue Implications of GST and Estimation of Rev .....

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t 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 Good .....

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inputs are used directly or indirectly by the sector. 9 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 10 Based on data for Karnataka, Maharashtra, Andhra Pradesh, Gujarat, Tamil Nadu, Bihar, Odisha, Chhattisgarh, Delhi, Uttar Pradesh, Jharkhand, Rajasthan, Madhya Pradesh, West Bengal, Harayana and Puducherry accounting for 78.5 per cent of the VAT base. 11 There have been other attempts at .....

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mpt 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. .....

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this was estimated at about ₹ 8800 crore in 2014-15), which has since shrunk to about ₹ 600-800 crores. It appears that the States did not take up the power ceded by the Centre, resulting in virtually no State-level taxation of textiles. 16 Another issue-a technical one-is that the calculation of the base uses the statutory rate of excise of 12.36% rather than the effective rate of 9%. 17 It is worth emphasizing that the ITT approach has itself undergone revision from a previous vers .....

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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 propor .....

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cy. 21 Taxing intermediates will, however, have the advantage of increasing the tax base via the withholding effect discussed earlier. 22 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). 23 The analysis ca .....

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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 .....

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group because the RNR will go up as a result of the implicit subsidy. The RNR will go up to a greater extent the more the leakage that occurs to non-target households. 32 So, for example, if the embedded taxes on a commodity is e (expressed in per cent), and t is the standard rate, then the effective subsidy rate of exempting a good is (t-e)/E, where E is the total expenditure of the target group. In contrast, if that good is taxed at the lower rate l, then the subsidy rate is (this ratio shoul .....

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ss 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 aggre .....

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