Power must come under GST; Here is why, how and when – The Financial Express–08.12.2017

Unrebated taxes on power Will lead to increased costs and lower margins by 1-3% for several industries, eroding competitiveness and undermining Make-in-India

As the Goods and Services Tax (GST) overcomes the transitional implementation challenges, it is time to look ahead to further improving it. The impact of the highest rates have been reduced by substantially paring down commodities in the 28% bracket. Simplification of procedures for small enterprises, especially those that sell to large enterprises, is under way. Bringing land and real estate into the GST is on the agenda for discussion. High priority must now also be accorded to the inclusion of electricity in the GST. Why, how, and when? Currently, there is a bewildering multiplicity of electricity taxes that vary by states and across user categories, low for consumers and high for industrial users. Taxes levied by the states thus vary from 0% to 25%. It is an important source of revenue for them, amounting to about `31,000 crore for all the states combined. On average, electricity taxes account for about 3% of own tax revenues of the states, going up to close to 9% in other states. States are therefore reluctant to give up the right to levy these taxes. But the status quo imposes large costs that seriously undermine the government’s Make in India initiative.

The most serious and obvious one is that costs to industrial users of electricity are higher because they include the taxes on inputs that have gone into the supply of electricity. These include taxes on raw materials (coal, renewables) and other equipment (solar panels and batteries). Not being part of the GST means that no input-tax credit can be claimed which results in embedding of the tax in the final price. For the textile industry, for example, these embedded taxes amount to about 2% of the price. This embedding of taxes hurts manufacturers selling to the domestic market. But they hurt in particular exporters of electricity-intensive products because they are not liable to any duty drawback—relief for taxes embedded in exports. But there is a subtler way in which these embedded taxes hurt industrial buyers of electricity, creating a double whammy for them. Electricity is finally purchased by consumers and industrial users. Politics, especially populist politics, has ensured that consumers (and other users in agriculture) pay either nothing for electricity or very little. As a result, and in order to make up for the resulting losses, discoms cross-subsidise, that is, they charge higher prices to industrial users to make up for under-charging others. But the embedding of taxes adds an extra layer of cross-subsidisation. Industrial users must also be charged higher rates to make up for the embedded taxes that cannot be recouped from consumers. Totalling up all of these effects could lead to increased costs and lower margins of between 1-3% for several industries. These margins are significant especially for exporters who face ferocious international competition and where a 1% extra cost could be fatal.

Another argument calls for its inclusion in the GST. Currently, there is a large bias in favour of renewables in GST policy. Inputs to renewables generation attract a GST rate of 5% while inputs to thermal generation attract higher rates of 18%. Supporting renewables might be conscious policy (and also good policy), but we are in a situation where subsidisation is proliferating across policy instruments, making it difficult to quantify the overall support. As we have discovered, complexity in the GST rate structure arises because it is burdened with having to meet multiple objectives. Support for renewables should be direct, conscious, and transparent. GST should not become the instrument for adding (non-transparently) to that support. If electricity were to be included in GST, then there would be no discrimination between renewables and thermal energy because all inputs going into both forms of electricity generation would receive tax credits. GST would then become neutral between different forms of electricity generation as good tax policy should be. Thus, the case for including electricity in the GST is compelling. The question is how? Recall that including electricity in the GST would reduce or eliminate embedded taxes in electricity-using products. That means that both the central and state governments would lose revenues that would now accrue as input tax credits to the private sector. In addition, state governments would lose taxes from electricity use itself. So, there would be two sources of losses. What should be the response? Several options are available. One would be for the Centre and the states to bear the losses of the embedded taxes since the benefits would also be shared. The Centre would then compensate the states only for the direct loss of revenues. Another would be a half-way solution. This would be to impose a 5% tax on electricity in the GST—allowing inputs tax credits to flow through the GST pipeline—but then allow state governments to impose a small non-GST able cess on top of the GST rate. In this case, however, the greater the cess, the more it would resemble the status quo with all its problems as described above. So, this half-way solution must come with some limits on state governments’ freedom to levy further taxes on electricity. But in both proposals the central government would lose revenues both from the loss in embedded taxes and from having to compensate the states.

The final question relates to timing. The likelihood of fiscal losses suggests that implementation should perhaps wait till GST revenues have stabilised, say, by the end of this fiscal year. Next fiscal year would then seem the right time for action, requiring the start of discussions in the GST Council soon. In sum, there are four clear benefits from bringing electricity into the GST: reducing the costs for manufacturing; improving the competitiveness of exporters; reducing the cross-subsidisation of electricity tariffs that further undermines the competitiveness of manufacturers and exporters; and eliminating the large biases—and hence restoring neutrality of incentives—in electricity generation. There would be costs in terms of foregone revenues but the benefits would be large and states could be partially or fully compensated. Indian manufacturing is saddled with costs. Efficient GST policy should aim to reduce them.

via Power must come under GST; Here is why, how and when – The Financial Express

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