Zhou Enlai, the Chinese Premier is said to have remarked when asked about the French Revolution, that it was ‘too early to tell’. This, remark perhaps apocryphal, was in 1972. This is even more true when discussing a sweeping tax reform like the Goods and Services Tax (GST) as it approaches just its fourth anniversary. However, anniversaries are opportune moments to savour the triumph, to analyse how things worked out and to map the way forward.
At the outset, it must be said that GST has lived up to its promise. It has subsumed the multiplicity of taxes, reduced the cascading impact, cut down logistics and transportation costs, given the country a common economic market and provided a technology-driven tax system.
Criticism has been on how GST could have been better. And the multiplicity of tax rates has been an issue which has particularly attracted a lot of critics. An ideal tax system which takes pride in simplicity should have a tax structure which is not multi-structured; a common rate across commodities making classification irrelevant being ideal.
There is no gainsaying the fact that the lesser the rates, the better, for both the taxpayer and the tax administrator. The pre-GST studies regarding rates had all suggested revenue-neutral rates (revenues as were being reached before the launch of GST to be generated even after the launch) ranging from 11.6 percent (IMF), to 12 percent (XIII Finance Commission) to 17 percent (NIPFP) to 15-15.5 percent (CEA). All the studies suggesting a common rate across commodities with minimal outliers; the assumption also was that exemptions would be pruned to a minimum.
This was never going to be practical. As is known, GST had merged the myriad indirect taxation laws—the central excise, the service tax, and the VAT laws of the states. While the rates of taxation were common across the country for all manufactured goods (central excise) and services, (service tax), the VAT rates differed across states. Hence, the weighted average of rates across central excise, service tax, and the rates of the various states were taken—this was necessary, simply because this being a step into the unknown, revenues had to be protected.
Further, nearly 50 percent of the items falling in the CPI (consumer price index) basket of commodities were exempted. Any tax reform to succeed had to be politically acceptable too. The result was a multiplicity of rates, 0,5,12,18 and 28. For good measure, there was a 3 percent for gold apart from multiple exemptions. This was inevitable—but not a good fiscal policy and drew a lot of flak.
The road map was, however, always clear, that the ultimate goal would be a convergence of rates—a standard rate for the vast majority of goods and services, and outliers, of a merit rate and a demerit rate.
An RBI report of 2019 estimated that the effective weighted average GST rate declined from 14.4 percent at the time of the introduction of the GST to 11.6 percent. It must be appreciated that even the rate of 14.4 percent was lesser than the average rates of Central Excise, Service Tax, and VAT as they existed. The IMF carried out an analysis at the behest of the Fifteenth Finance Commission (FFC) and has arrived at the current effective rate being about 11.8 percent. The result of this ill-thought-out reduction of rates in effect meant that the GST buoyancy during the period 2017-2020 was, as pointed out by the FFC, less than the subsumed taxes during 2011-2017. Revenue neutrality was lost very early on.
Currently, we are in a situation where there are about 183 items in the 0 percent slab, 308 in the 5 percent, 178 in the 12 percent, 517 in the 18 percent from where the bulk of the GST revenue comes, and 28 items in the 28 percent. GST revenue accounts for nearly 35 percent of the gross tax revenue of the Centre and about 44 percent of the State revenue pool.
It is in this background that the issue of the merger of rates has to be seen. So, when we talk of convergence and merger of rates, it should be remembered that this would mean not only reducing from 18 percent towards 15-15.5 percent but also increasing the rates of several commodities from 12 percent towards 15-15.5 percent. Any move towards convergence will also mean an exercise to rectify the consequential inverted duty structure which has grown steadily because of the random reduction in rates of final products. This having been done without examining the fallout—the rates of the inputs which go in the manufacture becoming higher in several cases, than the rate of the final product. Convergence would also mean severely pruning exemptions.
The road to convergence can also be less bumpy by ensuring the long-delayed expansion of the GST base. Petroleum products the golden goose of both Centre and the States, need to be brought into the GST net. Union excise duties have been contributing about 11.8 percent of the Centre’s gross tax revenue-much much more than the customs contribution of 5.8 percent. Around 17 percent on average of the non-GST revenue of the states comes from petroleum products. This is not an easy call more so in the backdrop of the stress on revenues. While everybody does appreciate that getting petroleum products within the GST net will reduce costs, improve compliance and has the potential to spur revenue, there is still a reluctance to do so.
Convergence thus is bound to be a difficult journey. But it is a road the GST Council has to take. The GST Council has been an outstanding collateral benefit of the tax reform. Enshrined in the Constitution, the GST Council is an embodiment of pooled sovereignty, of cooperative federalism. And it is an institution which of late has been taking a lot of beating from opposition party ruled states. Questions which would shake the very foundation of the Council are being raised—from the fundamental as to why all States are being treated equally, to the Centre said to be imposing its will through its fitment committee. This is unfortunate.
The Centre has a pivotal role to play in ensuring that trust is never lost. The compensation issue has been a sore point and needs to be handled carefully. The Centre has to ensure that the impression that it takes decisions unilaterally is not created. The Centre should use the forum of the Council to vigorously discuss and debate, to persuade and be persuaded. The suggestion that decisions regarding rates are taken by the implementation committee is patently incorrect. The fitment committee consists of officers from the Centre and the States and merely recommends to the GST Council; the Council it is which accepts or rejects the recommendations.
A lot is being made by some States that they have given up their powers of taxation to the GST Council. The Centre has also done so in respect of the taxes subsumed in GST. This was the basic premise on which GST was conceived. The fact that the Centre has taxation powers under Income Tax or Customs should not be an issue for the States—these two legislations were never a part of the GST scheme and further, the money so collected is distributed among the States as per the Finance Commission’s recommendations.
India’s federal structure is unique. In fact, as has been mentioned, the word ‘federal’ does not figure in the Constitution. It is a union of states—the glue being trust and in the case of GST, also compensation for revenue said to have been lost because of the implementation of GST. The Centre and the States have to continue working hand in hand, listening to and addressing each other’s concerns. In the meantime, let us cast aside these trifling issues and celebrate yet another anniversary of much-needed tax reform. It is in everybody’s interest—the Centre, the States, the tax administration and the tax payer to ensure that the reform works.
—Najib Shah is retd. Chairman of Central Board of Indirect Taxes and Customs. The views are personal.
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(Edited by : Ajay Vaishnav)