The Prime Minister’s announcement of GST reforms in his August 15 speech signals a welcome step towards meeting the original promise of a goods and services tax — that of a simple, unified indirect tax structure in the country. However, its effectiveness will depend on a consensus (via the GST Council) on the eventual rate structure and the subsequent reclassification of goods and services.
GST 2.0 will replace the existing rate schedule of 5, 12, 18 and 28 per cent with two slabs of 5 and 18 per cent, and the possible provision of a higher rate for “sin” goods at 40 per cent. It will also retain the structure of low rates (0-3 per cent) for items like bullion and jewellery. This remains far from the desired simple model of a single rate GST, as is the practice in federal countries like Canada and Australia. Albeit a step in the right direction, the new structure will still carry the problems of administrative complexity arising from multiple rates.
Multiple rates enable selectivity in rate setting, which increases compliance costs, adding to the complexity. When reclassifying goods and services across the new rates, the Council should try to avoid the pitfall of over-classifying items, which results in court rulings on whether cheese as pizza toppings should be treated separately from cheese. We should not be putting in time and resources deliberating on whether nuts produced locally are taxed differently from imported nuts that are not found locally.
A longstanding criticism of our multi-rate GST system is the inverted duty structure that results in high costs for businesses in the form of liquidity constraints, refund delays, and input tax credit denials. This arises when the final output is taxed at a lower GST rate than the intermediate inputs used in its production, leading to an accumulation of unutilised input tax credits. In narrowing the slabs, it would be important to minimise such distortions rather than exacerbate them by moving a final good from 12 per cent to 5 per cent while its intermediate input remains at 18 per cent. It also offers the opportunity to correct distorted tax structures in sectors like construction where intermediate inputs were being taxed in the range of 5-28 per cent.
The proposed model of a reduced rate (5 per cent), standard rate (18 per cent), and a sin or luxury rate begs the question of the principles that will underlie such a classification. An ideal GST is a non-distortionary tax which is completely neutral to the nature of the goods/economic activity being taxed. So, for better revenue outcome and for simplicity, most of the goods and services should be taxed at a standard rate. Reports indicate that most goods/services taxable at the 12 per cent slab will be moved to the 5 per cent category, narrowing the tax base and limiting revenue collection. Instead, the reverse should be done — most goods and services should be taxed at the standard rate. Since the 18 per cent category currently accounts for over two-thirds of the GST revenues, a broadening of this tax base would pave the way for lowering the standard rate with no loss in revenue. Furthermore, this reduction in standard rate will lower the GST burden for consumers and SMEs more than merging the 12 per cent category with the 5 per cent.
Any change in the GST structure in India should aspire to move to a regime where the use of reduced rates and exemptions is minimised. (Targeted transfers from tax revenues have been far more effective than reduced rates in achieving redistributive objectives, as has been seen across countries.) Deviation from this principle may require another major rate restructuring in the future. As the GST Council contemplates the number and nature of goods and services that will be moved from the 12 per cent category to 5 per cent, this very basic principle of GST design should not be compromised.
Another question is on the treatment of sin goods and luxury goods that currently face a GST rate of 28 per cent. Reports indicate that certain items will be pushed to a high slab of 40 per cent. Will this extend to all goods and services with negative externalities? Will it end up including ultra luxury goods? Will this category avoid the irrationalities present in the current 28 per cent slab, which treats tobacco at par with intermediate inputs like cement? To address the negative externality of sin goods and mobilise more revenue from luxury goods, states and the Centre should apply specific excise taxes on pre-determined and well-defined bases, in addition to the standard GST rates.
When we talk about GST 2.0, the critical consideration should be the asymmetric revenue impact of such a restructuring on the states. More than two-thirds of the own tax revenues of the states come from GST. In the case of the Union government, the share of GST in total tax revenue is 27.58 per cent. Thus, it has more headroom to accommodate the revenue fall due to the restructuring of GST. Since the GST compensation has ended, the revenue impact of GST 2.0 on states’ revenues needs to be factored in to ensure that their fiscal autonomy is maintained.
Finally, any reform in the GST design will be incomplete without resolving administrative issues in the implementation of GST. This includes addressing the problem of Inter-state Goods and Services Tax (IGST) settlement between Centre and states (which was taken up in the 55th GST Council meeting), and reducing the compliance and regulatory burden (from registration to assessment) on companies, particularly small and medium-sized ones.
Pandey is an independent economist and Chakraborty is former director, NIPFP
