Fiscal deficit, a reflection of government borrowings, is estimated to touch 6.8 percent in 2009-10, up from 6.2 percent in the previous fiscal, mainly on account of the stimulus measures.
The report deals with the issues of sharing tax revenue between centre and states, distribution of funds among states and support to local bodies.
The Finance Commission report assumes significance in view of the ongoing reforms in indirect and direct taxes, which will have a bearing on the tax collections. It fully endorses the GST as visionary, comprehensive and truly ‘flawless’.
The commission wants five GST exemptions and suggests a single tax rate of 7 percent by states and 5 percent by the centre. It recommends inclusion of all goods and services in the GST, including real property, banking services, petroleum, electricity, alcohol and tobacco.
Once GST comes into force, all other indirect taxes will go, including stamp duties, entry tax not in lieu of octroi, purchase tax, and the central sales tax (CST).
Tax experts say the new tax regime will have tremendous simplification and rationalisation of tax structure and could prove to be the tipping point for converting the Indian tax regime from one of the worst to one of the best in the world.
One of the interesting features of the report is the creation of a council of state finance ministers, which will be responsible for any modifications to the design of GST and for providing compensation to individual states for any loss in revenues due to GST. This body is an innovative compromise between the fiscal sovereignty of the states and the centre and the need for harmonisation and cooperation.
While the paper has clearly defined a vision for the new tax regime, there are many hurdles that remain. Even though the model outlined by the Finance Commission is a win-win for both the centre and the states, the states may be reluctant to take the giant leap that it entails. The states have been skeptical of the adequacy of the 7 percent to replace their current revenues.
The Finance Commission has spent endless hours to confirm the validity and robustness of this calculation. This rate is indeed adequate to replace the current state taxes and provide some surplus from improved compliance and larger GDP, which has not been factored by the Finance Commission while calculating the rate.
The second concern of the states will be the inclusion of sectors such as real estate and alcohol, which are the exclusive reserve of the states under the current constitutional division of taxation powers. Modern GST makes no exceptions for such sectors. Their inclusion in GST is essential to eliminate cascading and to ensure proper reporting and compliance by all sectors of the economy.
There are also certain technical features in the design of GST, which may prove to be challenging. Most notable among these is the taxation of banking services. No country in the world has been able to design a model for inclusion of financial services within a VAT/GST framework. India, if successful, will chart a new course, which could well become the model, which the rest of the world could emulate.
