State finance ministers met in Bhubaneswar on Monday, January 28, to discuss a blueprint for the transition to the goods and services tax (GST). A transition will eventually need a constitutional amendment, which would have to be approved by half the state assemblies.

GST talks: States agree on CST compensation

Given the long process and extraordinary consensus needed in a constitutional amendment, it is unwise to predict when the GST constitutional amendment will go through. However, what is of immediate interest is the steps the forthcoming Union Budget might take to prepare the ground for GST, thus, carrying forward the trend seen in the last two budgets.

Sanjiv Shankaran
GST is arguably India's most important economic reform today , and it aims to enhance the competitiveness of domestic manufacturing. A transition to GST would mean India will create a common market to go with common citizenship. It will be achieved by dismantling most tax barriers between states , which currently make the economy a patchwork quilt of different state laws.

In 2011/12 and 2012/13, former finance minister Pranab Mukherjee took the initiative to widen the tax base for GST even though negotiations with states were floundering.

In financial year 2011/12, Mukherjee brought into the tax net 130 of the 370 items that were not taxed under the Centre's exclusive domain of excise duty but subject to state taxes. The aim was to create a common basket of commodities that were taxed by the Centre and states to create an overlap for GST. Under GST, the centre and states partly surrender their exclusive tax domains, making it necessary to tax a common basket of commodities.

In 2012/13, Mukherjee widened the list of services that could be taxed. Services make up almost 60 per cent of the economy, but began to be taxed only in 1994/95. Today, this is the fastest growing segment of union taxes, estimated to bring in Rs 1.24 trillion in the current financial year.

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Mukherjee also fixed the median excise duty on commodities and service tax at a common 12 per cent, thereby removing the possibility of a key source of dispute between taxpayers and government. Increasingly, products such as computers contain elements of both commodities and services - the hardware and software in a computer, for instance. Different rates of taxation on goods and service lead to disputes - oftentimes the line of demarcation between a good and service is hazy in an evolving economy.

The question now is what Chidambaram will do to take this forward. Quite likely, the list of items exempt from tax will be reduced to widen the tax base before transitioning to GST. Typically, the wider the tax base, the lower the tax rates, as the burden is borne by a larger number.

Apart from a concrete measure on exemptions, what states will look for is the extent to which Budget 2013/14 will offset their loss of revenue from lowering tax rates earlier in preparation for a transition to GST. Without the right signals on adequate compensation, states are bound to be reluctant to surrender their exclusive rights to taxation.