It's called GST and it's coming for sure

A new inflation-boosting reform is on its way today - or maybe even 2013 - but it is coming for sure, sooner or later. It’s called GST, short for Goods and Services Tax.

Put simply, GST, when it is introduced, will replace a multiplicity of taxes at the central and state levels on goods and services - excise, service tax, value-added tax, entry tax, purchase tax - with one single consolidated tax (i.e. GST).

Sure, this is a nice reform to do, but it will also increase the ambit of taxation by bringing more and more services under it.

The states are wary, since it will reduce their taxation powers, and they cannot know if they will gain or lose by agreeing to GST. Which is why the introduction of GST is a political landmine, and many states like Gujarat, Tamil Nadu, Uttar Pradesh and Madhya Pradesh - all opposition-ruled - have been resisting the idea.

But businessmen and the centre are all for it - the former, because it will simplify their lives, and the latter, because it will bring in more moolah to waste on pork-barrel schemes.

It is a much-awaited reform, since it will simplify tax collection and reduce big-ticket corruption substantially, but its immediate impact will be an increase in the taxation of services - which, in the short-run, will push up prices of all untaxed services - and, therefore, generalinflation. Since services account for over 60 percent of GDP, one can only imagine what the taxation of this huge under-taxed sector will do to costs all around.

Last week, the Empowered Committee of State Finance Ministers announced a crucial step forward when it accepted the concept of a “negative list” of services which cannot be taxed by the centre.

The reason why this consensus is significant is simple: earlier, the centre had to list the services it wanted to tax. Now every service which is not on the negative list can be taxed. Thus if providing financial advice is not on the negative list, your personal finance advisor will have to pay service tax (or GST, once that happens) for giving you advice. If taxi services are not on the list, your taxi ride will face a tax (this already happens in Europe and countries which have introduced a value-added tax on all services).

This is how the inflation math works: if we take the contribution of services to GDP at 60-65 percent, we should expect 60 percent of our revenues to come from service tax. But currently service tax accounts for less than 10 percent of tax revenues.

According to a calculation by The Financial Express , once you remove government services (what service, one may ask, but that’s another story), the services on the negative list, and very small service providers from the ambit of service tax, you could still be left with 25-30 percent of GDP as the real service tax base.

This means the potential scope of service tax revenues suddenly doubles or trebles. In the 2011-12 budget, total service tax collections have been penciled in at Rs 82,000 crore (against customs and excise collections of Rs 1,51,700 crore and Rs 1,64,115 crore respectively). This target is going to be more than breached since the service sector is still growing robustly this year despite the overall slowdown.

Once GST comes in, services will not only become the biggest revenue contributor, but also the overwhelming one since it will subsume both excise and service tax into one Godzilla tax.

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Why are economists and the centre so gung-ho about GST? Two reasons:

One, it is easy to collect. The GST works like value-added tax (VAT), where a part supplier, say, an auto component maker, charges the cost price plus margins plus VAT before billing the automobile company. The automobile company, when it sells its car, charges VAT to the auto dealer, but deducts the taxes already paid by the components company from his tax dues. Since the auto company will not get this deduction unless the auto component maker has paid his taxes, effectively the buyer of goods (or services) acts as the person enforcing tax payments. This makes it easier for the government to collect taxes.

**Two, the GST includes both goods and services.**Taking the same automobile company, currently he will get duty setoffs only against the VAT (previously excise) paid on the component. But let’s suppose the automobile company hires a marketing consultant to push sales. The consultant can bill for his services by charging service tax on his fees. Without GST, the auto company will get a deduction only on the inputs that go into his product, not the services. Now the taxes paid by both the component company and the marketing consultant will be entitled for setoffs when GST is paid.

The down side of the GST is that it will bring hitherto untaxed services under taxation. The negative list agreed by state finance ministers last week talks of only excluding services like funeral, burial and mortuary agencies, interest paid on deposits by banks, dividend on investments and travel on public transport. Of course, the states will haggle over the final list, but one gets the drift. Once GST is in place, almost everything called a service can be taxed.

The other downside is that the ambit of taxation will be ever-widening - which could mean more costs for all of us, and more small-time corruption.

Here’s why. Since anyone who does not work for a salary will essentially be a service provider, all of them will have to register as service providers with the excise department. Individuals who are in the service tax category will thus have to file two returns - one with the excise department, and another with the income-tax department.

Moreover, since filing service tax entitles you to deductions on costs relating to the service - for example, if you are a marketing consultant, you can deduct the cost of maintaining an office or a secretary from your net income after service tax - this means you will need professional accountants and/or chartered accountants to do the job for you. Since GST will convert millions of service providers into GST payers, one can imagine the exponential need for accountants to take care of all their requirements.

But the biggest short-term impact of GST will be on prices. When you tax services that are currently not being taxed, the first impulse of those service providers will be to bill you for the service tax too - unless you make them swallow the tax and take a cut in income. When the costs of services rise, inflation will, too.

In the forthcoming budget , Pranab Mukherjee will sting you for more service tax, even if GST is not in place ( Read why it may take a while here ). What he will do is expand the list of services to be taxed, and the betting is that he will both raise excise and service taxes (which were cut in 2008-09, and only partially restored in 2010-11) to raise more revenues.