What is a good and simple tax and why is the present indirect tax structure bad and complicated? There are several reasons behind the bad, ugly and complicated visage — the constitutional structure, history and legacy, differential treatment of goods vis-à-vis services, multiple rates and exemptions. Exemptions mean loss in revenue. In 2015-16, such concessions/incentives on excise duty had a revenue impact of Rs 2,24,940 crore.
Stated more directly, had those concessions/ incentives not been there, revenue would have been that much more. In February 2016, there was a parliamentary question and, in response, the government gave figures for September 2015 — 1,36,365 indirect tax cases were pending, 40,967 before Supreme Court. The total sum involved was Rs 2,11,881 crore. Differences in rates, across items, are a primary reason behind tax disputes.
Ponder the following weighty matters. Is green coconut a fruit or a vegetable? Is Parachute oil, occasionally used for hair too, “coconut oil” or “hair oil”? Is Dant Manjan Lal toothpowder or a medicinal product? Is McDonald’s McSwirl ice-cream or a dairy product? Is Scrabble a game or a puzzle? These, and there are several more examples, are matters on which courts have had to adjudicate, because of differences in rates. Other than prohibition, differences in rates are the reason behind liquor being smuggled across borders and cars being bought and registered in a state other than the state of residence.
“Simple” is a simple and objectively determined adjective. Across goods and services, there should be a single rate for everything and no items should be outside the tax net. You do not leave out liquor, petroleum products, electricity or legal services. There is also a trade-off between “simple” and “good”, “good” being a term that is inherently subjective. Specifically, should indirect tax policy be used to address distributional concerns? Distributional concerns are indeed important. However, some issues of equity are beyond the purview of tax policy.
To the extent they are in the domain of tax policy, they pertain to direct taxes, where progressivity can be built in. But in many developing countries, India included, there is a perception that indirect taxes must reflect concerns of the poor and deflect items consumed by relatively rich. As soon as this thin end of the wedge is in, one is asking for trouble.
Mass consumption and elitist consumption involve subjective identification, based on static and arbitrary considerations. It also allows the insidious creeping in of lobbying for exemptions. Why did the excise exemptions mentioned earlier exist? Probably because someone lobbied for them. The exemption argument is simple. “Remove exemptions for others, but retain them for me.”
Think of the following items and ask whether they deserve a GST rate of 0 per cent, even with that pro-poor lens — meat, fish, newspapers, printed books. Everyone wants a lower tax rate, more on that later. But should the items mentioned, and there are more like that, be given a 0 per cent rate because they are essential goods and services? Roughly, 300 items in the Centre’s list and 80 items in the state list have such 0 per cent rates.
Why create an artificial threshold of Rs 1,000 between hotels that have higher room tariffs and lower? (There is another threshold at Rs 7,500). For garments, there is a threshold of Rs 1,000 and for footwear, one of Rs 500. Is shampoo a demerit good that it should be taxed at 28 per cent? A revenue neutral rate is a rate that yields the same revenue before and after the change. Computing a revenue neutral rate isn’t easy, because it’s hard to estimate volume growth and a broadening of the tax base. In all probability, with all items under GST, a revenue neutral rate would have been around 17 per cent, perhaps even 18 per cent. With several items at 0 per cent, 3 per cent, 5 per cent and 12 per cent, the weighted average rate of items included is probably below 18 per cent.
Make no mistake. Introducing the GST in a country like India is no mean achievement. Few countries (probably around seven) have the GST, though several have VAT. Of the ones that have the GST, Canada and India are probably the only ones that have some kind of federal structure. Of course, many Union and state taxes (central excise, service tax, VAT, entertainment tax, octroi/entry tax, purchase tax, luxury tax, taxes on lottery) have been unified and inter-state check-posts are vanishing.
The GST brings gains — efficiency (and thereby growth), lower compliance costs (for enterprises), lower collection costs (for governments), greater tax revenue. But empirical cross-country evidence (on VAT) indicates such gains happen when all items are included and there are no more than two or three rates. In working out compromise solutions, the GST Council has deviated quite a bit from that goal.
Concerns about rules (e-way bills, registrations, forms) are not that serious. They will sort themselves out, with tweaking here and there. Concern about the basic structure is more serious. Sure, there is hope that in the long run, there will be no more than two or three rates — a standard one, a merit (lower) and a demerit one (higher). There is the Keynes quote and let me give you all of it, not just the bit that is usually quoted. “The long run is a misleading guide to current affairs. In the long run we are all dead.”
What are those three rates likely to be? Probably something like 12 per cent, 18 per cent and 24 per cent. Everyone will happily accept reduction from 28 per cent to 24 per cent, if it occurs. No one will happily accept increase from 0 per cent, 3 per cent and 5 per cent to 12 per cent. Had it been that easy, the GST Council would have introduced it now. Once in place, a basic structure is not that easy to change, nor its consequences. Many old English houses continue to be dark because glass was heavily taxed, discouraging use of windows. Old houses in Amsterdam are narrow because taxes on houses were correlated with width of the façade. Similarly, on the basis of present rates, enterprises will take decisions and argue against change, even though promissory estoppel doesn’t apply to taxation.