Indirect tax reforms: half the battle; GST underperforms due to flawed design, rate hike agenda regressive

With the Indian Goods and Services Tax (GST) passing five years on June 30, it has just begun to show flashes of innate genius at best. Revenues have been very good in recent months, so the Center now expects revenue from this major indirect tax to be one-fifth higher in the current fiscal year than the Budget Estimate (BE) announced in February. In the past financial year, the collections grew by 30.5%, albeit on a contract basis (-7%).

However, GST produced a sub-optimal result over the half-decade, mainly because of its serious design flaws and policy ad hocism. The period, nevertheless, testified to the fact that even an imperfect GST can be decidedly superior to the system of various indirect taxes with a broader cascade effect that it has replaced.

As a destination-based consumption tax, GST was supposed to provide additional revenue, productivity and a significant “output effect” as tax is limited to value added only at each stage and B2B transactions are given a virtual pass-through status. These gains were hard to spot, at least until recently (GST revenue-to-GDP ratio was about 6.3% in both FY19 and FY22).

There is also no convincing evidence of a major cut in the tax burden on capital investment and manufacturing inputs boosting the economy, although this was also one of the promises.

Meanwhile, since the pandemic disrupted the economic landscape, opposing views on the efficacy of GST have remained just that: views.

To be fair, it was an arduous task for the then Treasury Secretary, Arun Jaitley, to negotiate a deal on GST’s structure with state governments after striking a grand deal. Implied in that agreement and the laws that soon followed were major changes in the way administrative powers and revenues are divided between the Center and the states and states themselves.

What was best was done, and it was a groundbreaking thing in itself. All major elements of indirect taxes levied by the Center and the States, except for the basic customs duty (import tariff), coincided in the new tax. But large parts of the economic transactions were excluded from the scope, especially automotive fuels, natural gas, land, real estate (construction for factory and civil works), alcohol and electricity. As a result, parts of the industry, including steel, cement and transportation, are unable to fully credit input tax paid while meeting their tax obligations.

Taxes are still paid on taxes. Economic tribulations have since forced the hands of policymakers, depriving them of any room for course correction.

So, as the GST council holds its 47th meeting in Chandigarh tomorrow, the main agenda will include a review of the GST tariff structure, with the aim of aligning the tariffs with the so-called revenue-neutral tariff (RNR) of about 15 % estimated before the introduction of the tax. There is no immediate plan to extend the tax to the vast areas left out, as both the Center and the states want to maintain discretion over the high-efficiency auto fuel taxes and avoid any uncertainties on this front. A series of tariff reductions – mainly of the highest tranche of 28% – and expansion of the exemption list have indeed increased the difference between RNR and the weighted average GST tariff (11.8% now) by three percentage points.

However, the council is likely to postpone a major overhaul of GST rates, which could include more rate increases than reductions and a reduction in the number of plates to 2 from about 4 now, to a future date, because the current high-inflation situation does not allow for major inflation. tax increases. The state governments are demanding that the soft protection of the revenues they have received over the past five years be extended. While only opposition-ruled states are making the claim public, other states, which are reluctant for political reasons, would certainly also like a longer compensation period. Some states have also spoken out against the tax itself and believe they would have been better off outside of it, although the facts do not support this view.

If the GST had produced the desired results, the council’s agenda would not have been rate increases and expanded income protections for states, but to give more tax credits to consumers from a high-income position. As such, high tax rates contradict the concept of a pure value-added tax with a large, almost comprehensive base, as the GST should be.

Countries that have successfully implemented GST/VAT systems have proven that broad tax bases and favorable rates lead to increased buoyancy. The key to increasing revenues is not higher rates and more taxes on a narrow universe of products and services (transactions), but broadening the base so that cascading is kept to the absolute minimum.

GST systems similar to India’s in Japan, Austria, Canada, South Africa and New Zealand are marked for much lower rates. These countries saw sudden increases in tax collection after the introduction of GST/VAT, which allowed them to gradually lower rates. Some, such as New Zealand, even brought rates below the RNR initially calculated. In India, there was reasonable revenue growth immediately after the launch of GST in July 2017. Revenues in FY19 were up 9% from FY18, while state VAT revenues excluding fuel taxes were up just 8.4% in FY17, on a very favorable basis.

First, the guaranteed income offered to the states (14% annual growth above the FY16 level) far outperformed the historical trend. GST receipts grew an average of 9.2% year-on-year in F19-FY22. By comparison, states’ VAT receipts, excluding fuel taxes, were up just 0.7% in FY14-FY17. In the past five years, a total of Rs 61.87 trillion was collected as GST receipts (including damages), but states were still awarded Rs 8.2 trillion in compensation, including the transfers of Rs 2.7 trillion made by the Center. were collected as a loan.

The five-year income protection for states was intended to offset the loss of their autonomous revenue margin (VAT). While states had agreed with the Center on an equal distribution of rights to the destination of GST revenue, many tax policy experts had recommended a higher share for them. For example, the Vijay Kelkar-led task force under the 13th Finance Commission had said 58% of GST revenue should go to states.

The current revenue growth is attributable to compliance improvements and policies that have spurred the “formalization” of the economy like GST itself. Efficiently curb false invoices, a system that allows credit disbursements only after technology-based invoices have been matched and stronger audit trails have increased revenue. But if the states look for revenue growth comparable to the past five years when some high growth was guaranteed, they would be in for a shock. A deficit of at least Rs 1 trillion on a combined basis is what they could expect in FY23 itself. Income protection has affected states’ tax efforts to some degree.

In a recent ruling, the Supreme Court reiterated that the Center and the states have concurrent powers to legislate on GST in a cooperative federal structure. This has inflated the threat that money-hungry states tend to stray from the path of consensus largely followed by the GST council. Such erratic tendencies would further undermine the country’s indirect tax system.

GST 2.0 reforms should bring auto fuels, land and real estate within the purview of the tax, in addition to correcting other structural issues that impede a seamless flow of pre-tax credits. This will help lower the general tax rate and unleash the factor market reforms needed to bolster the economy’s productive capacity. The current global economic slump and macro stability concerns may be constraints, but the new set of indirect tax reforms cannot wait too long.

(With input from Prasanta Sahu)

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