Extending service tax base will soothe states' fear
Experts will continue to argue over whether the government has done well to agree to the various exemptions the states wanted in order to get them to agree to the Goods and Service Tax (GST). Agreeing to keep many goods outside the GST will not only raise the revenue-neutral rate of taxation, it will ensure the various border check-posts will remain. Allowing states to continue with a 1% central sales tax—this is to lower the losses of producing-states who will see revenues fall under a GST structure since CST collections will fall—goes against not just the spirit of the common market, it vitiates the concept of a destination-based GST. While the debate between consuming and producing states can go on forever, the real question boils down to the actual or perceived losses of states, and this is the reason why the Centre has agreed to various concessions. The Centre’s logic is probably that there are lots of legislation that need to be pushed over the next year, so it is more important to keep the GST process going—the final details can be ironed out in a parallel process.
At the end of the day, the big game-changer here is service taxation. Obviously all producing states will lose more than consuming states once there is no CST, but if this money is more than made up by the states getting the power to tax services, most of the problem will disappear.
This is where the Centre needs to play a more pro-active role in raising service tax collections. Service taxes are the fastest-growing segment of the entire tax base. Between FY06 and FY15, assuming the budget is able to meet its service tax collections, they will have risen 9.4 times as compared to a mere 1.85 times for excise duties, 4.85 times for income tax, 3.1 times for customs and 4.45 for corporation taxes—gross tax revenues will have risen 3.71 times though, as the finance ministry’s mid-year review itself suggests, this will fall short due to a R1 lakh crore shortfall in taxes. Despite the huge jump of over 28% on an annualised basis since FY06, the fact is service tax collections are still a fraction of what they can be should the government studiously implement a policy of taxing all services subject to a small negative list. While service taxes comprise 15.8% of gross tax revenues in FY15, services comprise around 60% of GDP; excise collections in FY15 are projected to be roughly 15.1% of GDP, which is roughly equal to the share of manufacturing in GDP. While it is true not all services are taxable—government services are not taxed at all—there is little doubt service taxes can be raised in a big manner. Nothing will convince states about the GST more than a bigger push in this direction. Also, according to Kotak Institutional Equities Research, if service tax rates are raised to 16% and tax compliance increases so as to double revenues, the revenue-neutral GST rate could fall from 20.4% to 15.7%.