Maha Bharat: Episode 27

I’ve paid GST, now what happens to that money?

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It’s been over 3 years since GST was implemented and while it simplified a lot of things in India, many things became complicated. In this episode, we simplify the tax that meant to simplify all taxes. Has the “One Nation, One Tax” model worked? And most importantly, what happens to all the money collected by the government?

Show Notes

All clips and voices used in this podcast are owned by the original creators

Links to clips used in this episode —

Full Transcript of Episode 26 –

2007: the government decides to change the way India pays taxes. Years go by, the ruling party changes. In 2017, once again, the government declares (ailaan kiya): we will bring a revolution in India’s economy!

Yes, I’m talking about the Goods and Services Tax. The famous idea of One Nation, One Tax.

[We hear news clips about the declaration of GST]

But now, in 2020: after three years of GST, the centre is unable to compensate states for their losses from the GST collection. 

[We hear the voice of Mahua Moitra speaking in the parliament]

So, what really happened in these three years? And why do the states need to be compensated? Did GST work for us?

Actually, a good way to answer these questions is to understand the basics of the Goods and Services Tax. So, let me ask a new question, and we’ll try to answer it today. 

I just paid GST. What happens to that money now?

Doston, GST is one of those things that we hear about very often — but if I ask you how the GST system really works…well, it’s a confusing answer. But we’ll break it down today. 

GST, or the Goods and Services Tax, came into effect on 1st July 2017, during the first NDA government rule. This was such an important move, that not only was the Goods and Services Act passed in 2017, an amendment was also made to the constitution the year before. This was called the 122nd Amendment, and it added the provision of GST into the constitution. As the name suggests, the GST is a tax which is levied on production of goods (माल का उत्पादन) and the provision of services (सेवाओं का प्रावधान) in the country. 

The GST Act also mentions a GST council. This is a group of ministers who discuss and decide on how much tax should be levied (कितना टैक्स लगाया जाना चाहिए), and makes recommendations to the centre and the states on policies regarding GST.

But before we go into the details of GST, an important question to ask is: what did the GST replace? Why was this change needed?

Of course, 2017 wasn’t the first time that goods and services started being taxed. Before this, the tax system was divided into two: direct and indirect taxes. Direct taxes are mostly taxes on income and wealth, which are paid directly to the government. For example, the income tax. 

Indirect Taxes, on the other hand, are the taxes levied on various goods or services. Even though it is paid to the government by the seller or service provider, the consumer bears its costs. Mushkil ki baat yeh thi, ki even in a single occupation, you would have to pay multiple taxes.

Ek example lete hai. Suppose you manufacture clothes. You import some raw material into the country to manufacture these clothes. You have to pay a tax called custom duty on the raw material you imported. Now, you manufacture the clothes, but when it’s time for the boxes of your clothes to leave the factory, you must pay an excise duty to the central government. If you want to sell these clothes to a wholesaler or retailer in your state, you will have to pay VAT – value added tax to the state government. And if you want to sell it to someone in another state, then CST — or Central Sales Tax to the central government. If you decide to send your own truck to this state with the boxes of clothes, then you’ll have to pay octroi (ऑक्ट्राय), which is a tax levied on the entry to another state. There’s one thing you must have noticed here: you’re paying tax on an amount which already includes the tax that has been paid at a previous stage. This tax-on-tax effect is called the cascading effect, and it can cause huge losses to a manufacturer or a trader.

So, yes. The Indirect Tax system was a long and complicated process.

But, it’s not like we did not realize it. Reforms in our taxation system had been happening, one by one, until it all led to the biggest reform: the Goods and Services Tax.

The concept of ‘one nation-one tax’ is considered to be such an important reform, because for as long as we have known, India has had a system of multiple taxes. Both direct and indirect taxes have been in place for longer than you would think.

In fact, the taxation system in India has an interesting origin.

You might be surprised to know that even 3000 years ago, in Ancient India, the taxes charged were quite similar to those we pay now! For instance, there was a sort of sales tax called Vyaaji (व्याजी) during the vedic period, a luxury tax was charged on expensive items. We pay a tax on imported goods today, called customs duty. In the vedic period, a merchant who entered a kingdom with his goods would have to give a suitable gift to the king. This was an early version of the customs duty!

The income tax, too, was not a new concept for us: it was mentioned clearly in Kautilya’s Arthashastra and the Shrimad Bhagwat. For instance, in Arthashastra, Kautilya mentions that a tax of 16% should be levied on agriculture. Writing about tax, Kautilya says “Kosh Mool Dand” (कोष मूलो दण्डः), which means ‘revenue is the backbone of administration’. Interestingly, this phrase is still printed on the Income Tax logo in our country!

In the British Era, a formal structure of taxes emerged. First, we had income tax  and then new types of indirect taxes were introduced.

But how did so many types of indirect taxes come into the picture?

In the 1800s, the British charged a tax on imported goods, and this was the customs duty. This was one of the first kinds of indirect taxes charged — it was followed by the excise duty, soon.

In the early 1900s, if you walked into a market in India, you would probably find two types of clothing stores: one with clothes imported by the British, and another with Khadi clothes made in India. The imported clothes were of course much more expensive than the Indian ones. Common people could not afford these imported clothes. This is when the British imposed a tax on goods manufactured in India: the excise duty. Excise was applied not only on Khadi but also salt, sugar etc. 

Excise duty was continued after Independence, and dheere-dheere other indirect taxes were imposed. They were introduced because of different reasons. For instance — did you know that the Sales Tax started out as a tax that was implemented just on the sale of Tobacco in Bombay? What happened is, the Government of India Act of 1935 allowed the states to impose a tax on goods and services within their own states. Bombay was the first province in 1938 to impose a tax on the sale of tobacco. Soon after, the Central Provinces, Bengal, and Madras followed by imposing a general sales tax.

I’m sure you now understand just why the manufacturers, traders and even the common people of our country complained about indirect taxes. Not only were we paying an extra tax, the entire process was too complicated. Both the state and the central government were levying taxes in their own separate ways. This system needed to be replaced.

We now know that GST came into effect under the NDA regime, in 2017. But, the idea of a one integrated tax system for the country originated more than 20 years before that. What do I mean by an integrated tax system? Matlab, instead of all these different indirect taxes being levied at different stages of manufacturing, just one tax will be paid at a fixed interval. 

In 1994, the Amaresh Bagchi report suggested that a Value Added Tax should be introduced in India, which will lead to the Goods and Services Tax eventually. Remember taxes-on-taxes? Value Added Tax would essentially get rid of this problem, and charge a tax only on the value added at each stage of manufacturing. 

Don’t let this jargon confuse you — what this means is, that tax would only be imposed on the cost added by a person in the chain of manufacturing. For instance, if I buy flour at Rs. 50 and bake a cake out of it. I would add Rs. 50 for my labour and sell it to you at Rs. 100. You would have to pay a VAT not on Rs. 100 — but only on Rs. 50, which is the value I added to the product, the cake!

But this suggestion wasn’t put into practice until 2004, when the Kelkar Task Force insisted on a tax reform in the country.

2005 can be considered an important year for the tax system in our country. This is when The Value Added Tax, or VAT was finally introduced. It replaced the Sales Tax in the country. 

This is our finance minister at that time, P. Chidambaram announcing it in his Budget speech:

[We hear the voice of P. Chidambaram announcing the budget]

It was a long process, for sure, but 12 years later, India finally saw the one nation, one tax goal come true.

SOUND BREAK

Indirect tax, history, speech — yeh sab toh samajh liya. But let’s get to the point (mudde ki baat karte hai).

How does GST even work?

To understand this, let’s take a simplified example. 

First of all, GST is primarily paid for by a manufacturer, wholesaler or a retailer – directly to the government. Basically, anyone who makes and sells you a good or a service. But hota kya hai, that these manufacturers then add the GST that they have paid to the price of the product. This is ultimately added to the MRP — matlab, end mein, consumers like you and me are the ones who pay the GST. Think of the manufacturer as simply…someone who collects your tax and passes it on to the government. I know, I know, a little strange. But let’s see how it works. 

Let’s say there are 4 characters in our story. A,B,C and D. A is a manufacturer, B is the wholesaler, C is the retailer and D is the consumer yaani aap. (please use names if you want for these?)

Let’s go back to, say…2012. This is before GST. 

‘A’ has a factory that manufactures clothes. For this, he buys various raw materials. Suppose to make a T-shirt, A buys Rs. 100 worth of raw material. He makes a t-shirt, and adds Rs. 50 for his labour and profit. The T-shirt is now Rs. 150. But before he sells it, he must pay a tax to the government, so he adds the cost of this tax to the T-shirt and passes on the tax to the wholesaler. For our understanding, let’s suppose the tax is 10%. So, A pays 10% of 150, which is Rs. 15 as tax. 

He sells the T-shirt to B at Rs. 165. B, the wholesaler, attaches labels to this t-shirt. This is the “value” that he’s adding at this stage. For this value and his profit, B adds Rs. 35 to the T-Shirt. Is the price of the T-shirt now Rs. 200? — wait! B must pay another tax to the government before he can sell this T-shirt to C. Let’s again assume the tax here is 10%, so B pays Rs. 20 to the government and adds it to the cost of the T-shirt. 

C buys the T-shirt for Rs. 220. To keep it in his fancy shop and make a profit, he adds Rs. 30 to the T-shirt, making it Rs. 250. Oh, but before he can sell it to a customer, he must pay a tax again: Rs. 25 to the government. C adds this to the cost.

When D, the customer, walks into the shop and looks at the label of the t-shirt, he’ll see Rs. 275.

I hope you’re with me so far! Did you notice: at every stage, the person was paying a tax on an amount which already included a paid tax! 

And ultimately, the consumer has to bear the cost of all these taxes. 

But let’s jump forward to a few years later, in 2018, when A,B,C,D are still in business. But this time, GST is in place. This means that at every stage of manufacturing, the person only pays one tax: GST. And this tax is levied only on the added “value” on the product or service, and not the whole price. 

Matlab?

Let’s start with the same prices. 100 rupees of raw material, and 50 rupees of value, and A sells the T-Shirt at 150 rupees + 15 rupees of tax. Now when B adds his profit and goes to sell it at 200, he has to pay 20 rupees of tax like before, but now, what he can do is deduct the 15 rupees already paid by A and only pay the balance of 5 rupees to the Government as tax, and this continues the same way throughout the chain.

Aur isse kya hoga? In the end, the cost of the T-shirt will reduce, because the manufacturers and retailers are not paying a double tax anymore. 

In short, instead of paying extra because of a few different taxes at every stage, A, B and C deduct the tax already paid and pay a single tax: the Goods and Services Tax. Aur yeh deduction ka funda kya hai? Tax ki bhasha mein, this is called input credit. 

But like you saw, the GST paid by the person at every stage is passed on and on until the customer pays for it. This is true for every product you buy, even a small detergent bar. The price is inclusive of GST. So, this is what I mean when I say that A,B,C are just carriers. We are the ones paying GST — they are simply paying it to the government on our behalf. 

GST is filed by the taxpayer every month. By taxpayer, I mean anyone who sells a good or a service. The GST of a particular month is filed before the 20th of the next month. 

Alright, GST paid, T-shirt sold, all done. But yeh GST aakhir jaata kahan hai?

Arun Jaitley answered this question in the Parliament: 

[We hear the voice of Arun Jaitley speaking in the Parliament]

According to Arun Jaitley ji, most of the GST money ends up in the hands of the states. Let’s see what he means — and if it really is true. 

India wasn’t the first country to implement GST — all the way back in 1954, France was the first country to do so. And since then, many countries have followed. What the countries do is follow the theory of one nation-one tax, but implemented in a manner that works best for them. For instance, in Australia, the centre collects the entire GST and then distributes them to the states. Canada follows a dual-GST system, which means GST is collected at the central and state government level separately.

India also does something similar. 

In India, the Goods and Services Tax is divided into 3: the State GST, Central GST and Integrated GST. Matlab, SGST, CGST and IGST. If there is an exchange of goods or services within the state, then you’ll have to pay CGST as well as SGST. Basically, your total amount of GST is divided into two. One half goes directly to the states, and one directly to the centre. If there is any supply of goods or services between different states, then you have to pay IGST, which goes straight to the centre. 

Another question is, how much GST to pay? There are four slabs — matlab, 4 categories — of GST payments. First is 5%. 5% GST is applicable on coffee, tea, bread, spices, medicines, frozen vegetables, small restaurants, etc. 14% of all goods and services fall in this slab. 

Next is the 12% slab — this includes frozen meat, packaged butter and cheese, non-Ac restaurants, a business class air ticket. 

Next, and slightly higher, is the 18% slab and in this slab are items like biscuits, pan masala, cameras, telecom services. The most number of goods and services, almost 43%, fall in this category! 

The highest tax slab is 28% includes the most expensive goods and services — automobiles, electronics, 5-star and luxury hotels. 

There is also a zero slab — matlab, items jispe there is absolutely no GST. Jaise, fresh fruits and vegetables, milk, meat, eggs, newspapers…even bindi and sindoor! In 2018, after protests, the government also added Sanitary Napkins to this list. 

Let’s not forget that there are items kept completely outside the GST system. These items will continue as they were before — with the previous taxes. Alcohol for human consumption and petroleum products fall in this category.

Let’s come back to the GST money. So, 50% of your GST goes to the state, and 50% to the centre. This money is collected in the consolidated funds of each. What I mean is, the money goes into a fund from where the States and the centre then use it for their day-to-day expenditure. 

Now, remember Arun Jaitley ji mentioned something called the Centrally Sponsored Schemes? Well, these are basically welfare schemes that the states carry out, but they are funded by both: the state and the central government. The most popular example of this is the Swachh Bharat Mission. But there was a bigger number mentioned in Jaitley ji’s explanation…42%! He was talking about the tax devolution (डिवोलुशन) 

Tax Devolution is basically the transfer of funds from the centre to the states. The states are free to use these funds as they like. In 2013, the 14th Finance Commission recommended that the centre transfer 42% of the tax money received to the states. So, this is what Jaitley ji meant. And we can assume, this is where our GST money goes!

But doston, you and I both know that laws on paper – or for that matter, speeches in the parliament, are not always the same as what happens in real life. 

Yes, SGST does go directly to the states. However, if you remember Mahua Moitra’s speech in the very beginning of this episode, she mentioned compensation for the states. Before GST, almost all of the state revenue came from Indirect taxes. For GST to be implemented, the states gave up this source of revenue. This was because the Centre promised to compensate the states for their losses. However, in the recent monsoon session of the Parliament, a report from the CAG of India revealed that the Centre has not compensated the states. And the states are now out of money — so something must be done.

The states were given two options by the central government: They can either borrow Rs. 97,0000 crore from a special RBI provision set up by the government — this is the amount of compensation by the centre. The second option is, the states can borrow the entire shortfall of Rs. 2.35 lakh crore which is the entire shortfall of the states due to implementation of GST. The catch here is that in the first option, the states don’t have to pay interest, while they will have to do so for the second option, to receive money that was due to them in the first place!

So far, 21 states have agreed to option 1. And as I’m talking to you, the deliberations (charcha) between the states and the centre regarding this compensation is still going on. 

But Jaitley ji is right about the devolution of taxes. The centre tries to transfer funds to the states in periodic intervals. In May this year, it released more than ₹6000 crores to 14 states (14 states mein baanta). But as far as centrally sponsored schemes are concerned, the situation might be a worry. While the Central budget does have the space for these schemes, it is the states that don’t have the revenue to fund these schemes.

Doston, once you pay GST, the rest is in the hands of the government. Ideally, the money should come back to the states. But as we saw, there are complications when it comes to this. 

There is one question that I’d like to end with: has GST been successful?

It’s safe to say that there are definitely people who will say no:

[We hear the voice of Rahul Gandhi]

That was Rahul Gandhi ji at a rally in Gujarat. What he meant to say is that GST hasn’t been as successful as the BJP government wanted it to be. In fact, it may have created confusion for small businessmen and traders, who had to change their entire tax system. In 2019, even Prime Minister Modi acknowledged this in an interview with ANI — GST has caused inconvenience to small traders. There are various reasons for this, including a new system of filing taxes, and the huge penalty if you don’t file on time. 

In many parts of the country, GST has also failed to bring a change in the MRP of prices. Remember A,B,C and D? Well, in many real life cases, they deduct the input credit so that tax reduces, but continue to keep the MRP at the same rate. In this way, profit increases.

The benefits of GST are many — as we saw today. But the country may need some more time for these benefits to come true. A complete tax reform in the country is no easy task. Whether GST has succeeded or failed is perhaps a question we can answer with certainty only in a few years.

That’s all I have for you today! I know no one likes paying taxes — but it’s just as important to know what happens to the taxes we do pay. I hope we were able to understand just that. 

I’ll be back next week with a new episode of Maha Bharat!

Credits

Narrated by – Dhruv Rathee
Producer – Gaurav Vaz
Written by – Anushka Mukherjee and Gaurav Vaz
Edited by – Medha V
Title Track Design – Abhijith Nath
Audio Production – Madhav Ayachit