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GST revenue accounts for 35% of the gross tax revenue of the Centre, 44% of the State revenue pool.
A GST Council meeting is due to take place soon. And the debate about the multiplicity of rates has started yet again. Though discussed many times earlier, it is still important to put in perspective how and why the multiplicity of rates was arrived at when the GST laws were being conceptualized. 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. It had to be ensured that revenues, as were being reached before the launch of GST, were being generated even after the launch - the concept of revenue neutrality. 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 good fiscal policy and drew a lot of flak.
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The road map was, however, always clear, that the ultimate goal would be a convergence of rates - a merit rate, standard rate, and demerit rate. In the meantime, for considerations other than fiscal, the rates, especially the 28 percent slab, kept getting whittled. So, revenue neutrality was compromised very early on.
An RBI report of 2019 estimated that the effective weighted average GST rate declined from 14.4 percent at the time of introduction of the GST to 11.6 percent. It must be appreciated that even the rate of 14.4 percent was lesser than the 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.
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. Any change in the rate structure has ramifications across the Centre and the states. And given the compensation burden which the Centre has taken upon itself, would possibly mean an additional burden for the Centre.
It is in this background that the issue of merger of rates has to be seen. There is no gainsaying the fact that the lesser the rates, the better, for both the taxpayer and the tax administrator. The earlier studies both by NIPFP and the then CEA had suggested a median Revenue Neutral Rate (RNR) of about 17 percent and 15-15.5 percent respectively. 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.
An exercise of convergence is desirable but has serious implications which should not be forgotten in the cacophony and rhetoric of armchair columnists. And the GST council has to be sure that this course of action is what is needed at this juncture.
The focus instead should be on the long-delayed expansion of the GST base. Petroleum products the golden goose of both Centre and the States, need to be brought into 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.
Similarly, the electricity that is outside the GST net needs to be brought in. The cleaning up of the inverted duty structure is also overdue. The indiscriminate levy of cesses, with the Agriculture Infrastructure Development Cess (AIDC) proposed in the recent Budget being the latest, militates against the concept of GST.
What needs to be also done is to improve compliance. The FFC has also pointed out that the gap between the potential of GST collections and the actual collection is 2 percent of GDP. This is huge. This brings us to the functioning of GSTN. While its functioning has been steadily improving, there is still much to be done. Technology ultimately has to ensure analysis of data, risk profiling, and targeted action against evaders. Tax administration needs strengthening; this also means ensuring speedy dispute resolution. Adjudication should be not just swift but also consistent with the statute and jurisprudence.
A myth has been created that the ‘art of taxation consists in plucking the largest amount of feathers with the smallest amount of hissing’. Unless you were to anesthetize the goose, hiss it surely will. The GST council should thus focus on reforms that will have a significant impact on revenue and reduce costs. None, of these, are going to be easy - but then who said it was?
—Najib Shah is the former chairman of the Central Board of Indirect Taxes & Customs. The views expressed are personal
Read his other columns here