It is impressive that the Centre has taken the difficult task of resetting the over-eight-year-old goods and services tax (GST) head-on. The structure, administration, and revenue-sharing mechanism of GST has turned unnecessarily complex over the years. To be sure, even from the very beginning of India’s GST, much was left wanting. A clutch of product categories and thereby a fairly large section of the economy, was kept outside the tax’s purview. With petroleum products, electricity, and real estate (transactions of completed properties) having been kept out, the principal purpose of GST, which is to reduce cascading of taxes to the extent possible, hasn’t been met satisfactorily.
As a result, the long-standing issue of redundant tax costs to businesses largely persisted. Units burdened with accumulated, unusable input tax credit (ITC) have had little incentive to pass on the “benefits” of tax rate reductions to the consumers, and the tendency to evade the tax lingered. The structural infirmity has harmed smaller firms more, because unlike the larger diversified ones their ability to use input taxes for meeting output tax liability is limited. Paradoxically, the tax treatment of larger and smaller firms has turned more disparate in the GST regime than in the previous one. Moreover, the opaqueness in and the delays over how the integrated GST proceeds are apportioned and distributed has generated heartburn among several states.
GST revenue challenges
As a fallout of all this, the GST’s promised economic and revenue benefits have remained a mirage. Revenues from this tax have risen but just about reached pre-GST level of nearly 7% of the GDP, and appear to plateau already. The prime minister’s announcement to reform the GST and reduce the taxes on everyday use items may appear to pre-empt the GST Council, where the Centre and states are equal partners. But unless such a bold initiative is taken, a major redesign of GST, which is inevitable for its structural improvement, would have been delayed inordinately. Also, the PM has set the direction of the reforms right by promising to reduce the tax incidence. Some circles, betting on the “revenue neutrality” principle, were expecting the weighted average rate (WER) to rise after a rate/slab recast.
The question is whether the essentially two-tier structure (5% and 18%), coupled with a great deal of deliberate resolution of “inverted duty structure”, would indeed be capable of addressing the tax’s structural shortcomings. Though the details are yet to be worked out, what can be deduced from the information made available is that tax incidence on several daily use items, common inputs for micro, small, and medium enterprises, and agriculture, cars and two-wheelers except the truly high-end ones, several consumer durables, and even a clutch of fast-moving consumer goods items, would reduce—quite substantially in many cases.
Towards meaningful reform
Former finance secretary Vijay Kelkar has long called for a single-rate (12%) GST with full ITC. Late economist Bibek Debroy also advocated single-rate though he wanted the WER to rise, and help raise the tax-GDP ratio. Given the traits of the economy, a single-rate indirect tax may be too much to ask for. That said, a truly beneficial reform of GST will restrict the universe of exemptions (both in terms of the size of units and products), and let smaller businesses join the formal economic value chain. It will also democratise the administration with an empowered, neutral secretariat, and move further on the path of federalism, by assigning a portion of the revenues to the local bodies, the third tier of government.