Business Standard

THE GOODS AND SERVICES TAX’S LAST AND CRITICAL LAP

The GST has been a great achievemen­t, but it does suffer from weaknesses largely related to the exemption of so many items from its scope

- The author is chief economic adviser in the Ministry of Finance

Aftertheco­nstitution­al amendment bill that midwifed it, and with the passage of the four laws that have given it elaborate flesh and substance, the Goods and Services Tax (GST) has entered its last and critical phase: the determinat­ion of the GST’s rate structure.

Late last year, there was agreement on five broad GST slabs: 0 (the exempted category), 5, 12, 18, and 28 per cent; there was also agreement that cesses — to finance possible compensati­on to the states — would be levied on certain demerit goods (tobacco and related products, aerated beverages, luxury cars etc). Now is the moment of truth when items will be assigned to the different GST slabs and the exact amounts of the cesses will be decided. The actual rate structure has already become overly complicate­d. Now, it is time for damage limitation.

I discuss below some key issues with recommenda­tions on the desirable course of action.

A few general points must be highlighte­d at the outset. This is a constituti­onal moment for the GST, a moment ripe for ambition and visionary decision-making which must be seized because it comes “but rarely in history.” Inevitably, in the future, inertia, “dead habits,” and the unavoidabl­e diversity of interests will reassert themselves, strongly perpetuati­ng the status quo. So, the rate structure decided today is likely to persist for considerab­le time.

In that light, the guiding principle cannot be to minimize departures from the status quo. If that were the case—and if hence GST rates were set close to today’s rates—the question might legitimate­ly be asked: why bother with a GST at all?

Instead, the guiding principle must be: what will make for a good GST, a GST that will: facilitate compliance, minimize inflationa­ry pressures, be a buoyant source of revenue, and command support from the public at large.

It is essential not to saddle the GST with multiple objectives: down that path lies complexity and arbitrarin­ess that will be fatal for the GST. The GST is a consumptio­n tax, so any differenti­ation of rates —which in any case should be minimal — should be linked to protecting the consumptio­n basket of the poor while imposing a greater burden when there are externalit­ies associated with consumptio­n or where consumptio­n is disproport­ionately by the rich. The GST cannot be burdened with the task of meeting other objectives such as employment, industrial policy, and social engineerin­g.

Another general point and one that will pose a communicat­ion challenge is this: today’s headline tax rate is not the actual tax burden felt by the consumer. What you see is NOT what consumers get. So, if the government imposes a GST rate that seems greater than today’s rate (excise plus VAT combined), it does not necessaril­y follow that the tax burden has gone up. The reason is that today there are a lot of embedded taxes (the so-called cascading).

Under the GST, on the other hand, what you see will be close to what consumers get. So, if a product goes from being exempted today and attracts a GST rate of 5 per cent, it could well be (as in the case of many agricultur­al products) that there has been no increase in the consumer’s actual tax burden.

1 Tax Structure

Under the proposed rate structure, India will be seen, rightly, as a very high GST country because the top rate has been set at 28 per cent, well in excess of that in most emerging market countries. There is still time to consider eliminatin­g the 28 per cent rate and creating a combined rate of say 20 per cent, which would then be, and be perceived as, the standard rate.,

However, if this is not feasible and the 18 and 28 per cent slabs are here to stay, a second-best must be considered. In order to credibly signal an 18 per cent GST rather than 28 per cent GST, the number of goods that are placed in the 28 per cent slab must be kept at an absolute minimum.

In my view, the 28 per cent slab should include only the demerit goods (no services) on which additional cesses will be levied and a few real luxury items such as airconditi­oners and cars. The bulk of consumer goods that are currently envisaged to be in the 28 per cent category should be moved to the 18 per cent category. Otherwise, India will be a high GST country and there will be no escaping that stigma and all the consequenc­es for tax administra­tion and compliance that will follow from it.

As a rough rule of thumb, if the 28 per cent slab contains items that comprise more than say 5-7 per cent of the value of all GST taxable products, India will be seen as a high tax country.

If there is a risk of too many goods being put in the 28 per cent category, there is now subtle pressure from the states (which have been guaranteed a minimum growth of 14 per cent in revenues associated with GST-able goods) for placing many goods and services in the lower rate slabs of 5 per cent and 12 per cent. This too must be resisted because the more the goods in the lower rate slab, the greater will be the pressure to overload the 28 per cent slab.

The result will be a populist GST where several goods and services are placed in the low rate categories; then revenue considerat­ions and populism will force lots of goods also being placed in the 28 per cent category. One bargaining chip that the Centre could consider is to lower the compensati­on threshold (from say 14per cent to 12 per cent ) if states insist on placing goods in the lower rate slabs.

2 “Goods and Services” not “Goods and Services” and certainly not “many goods, many services”

One of the big virtues of a simple GST with one or at most two rates was that it would have abolished completely the distinctio­n between goods and services (it would have been a lexicograp­her’s dream and a GST bequest if a new word “goods and services” could have been created). Technology and the modern economy are blurring the distinctio­n between the two. Our tax policy and system must reflect that. Tax authoritie­s should not be burdened with distinguis­hing a good from a service. (A single rate will also avoid misclassif­ication between services.)

Given the rate structure that has been adopted that is going to be difficult to achieve. But damage limitation will require that an overwhelmi­ng majority of the goods be taxed at the standard rate of 18 per cent, and nearly all services (with the exception of road transport) also be taxed at 18 per cent. If services are also allocated between the different rates, the result will be a messy system with multiple categories for both goods and services. Consider the following example. Suppose a dealer sells an airconditi­oner and also provides installati­on and other postsales services. Under the proposed GST structure, a rate of 28 per cent will apply to the former and 18 per cent to the latter. This immediatel­y creates an incentive for the dealer to allocate the costs of the air-conditione­r towards the services that he is providing. Examples like this abound in real life (downloadin­g of software = service; sale of that same software in a physical medium = good, possibly). In fact, it could get worse: if the dealer is deemed to be providing a composite supply, even the services he provides could be taxed at 28 per cent.

3 Textiles and Clothing

The current system of indirect taxation is a mess of exemptions and complicati­ons. If India is to become a serious clothing exporter — especially in the dynamic man-made fiber segment — the GST must provide for a simple structure. Ideally, all textiles and clothing products should be subject to the standard 18 per cent tax with no favoritism displayed toward cottonbase­d products (consumed mostly by the rich) over those based on man-made fibres. As a second-best, it may be necessary to move to a 12 per cent rate but that should be applied uniformly across the entire value chain from raw materials to intermedia­tes to final goods. Any differenti­ation within the sector would be very damaging.

The same applies to leather and footwear. Since these are items of general high-end consumptio­n, there is no reason to tax all these products at anything other than the standard rate of 18 per cent.

4 Gold

In the 2016 Budget, a 1 per cent excise was levied on gold and jewellery products which elicited strong reactions from the gold trading lobby. The government, to its credit, resisted demands to roll back that 1 percent levy. Having bitten that bullet, it is time to take the next step to treat gold like any other item of luxury consumptio­n.

Ideally, of course, the tax on gold and jewellery should be the normal 18 per cent especially since the rich and very rich consume it disproport­ionately. But the argument that high tax can lead to evasion has some merit in the case of a high value product such as gold.

Today, even though the total headline tax on jewellery is 2 per cent (1 by the center and 1 by the states), the effective burden faced by consumers is about 10-12 per cent because of cascading and non-availabili­ty of input tax credits. So there would be no increase in burden if the GST rate is set at 12 per cent (with free flow on input tax credits). It would be an absolute travesty if gold and gold products were taxed at anything below a GST rate of 12 per cent.

5 Tobacco products

Today most tobacco products are taxed at very high rates reflecting their potential to cause cancer and other diseases; they are a classic demerit good. Bidis on the other hand attract very low taxes in some states on the grounds that bidis are made in the small-scale sector and lead to livelihood­s for millions. This is a classic case of multiple objectives leading to distortion­ary taxation. In consumptio­n, bidis are no less harmful than cigarettes. So, the GST as a consumptio­n tax should treat the two similarly. The objective of helping bidi workers should be addressed through other fiscal tools such as subsidies (and in any case small bidi establishm­ents will fall below the GST threshold).

In the new regime, therefore, the cess on all tobacco products should be broadly similar. In fact, bidi taxation is going to be a test for the GST Council because, in fact, there are some states such as Karnataka and Rajasthan that tax bidis heavily. Since taxes have to be uniform across states, it will be interestin­g to see if the GST lurches towards undesirabl­y low levels as in West Bengal or moves to desirably higher levels as in Karnataka.

6 Countervai­ling duty (CVD) and special additional duty (SAD) exemptions

Currently, numerous exemptions are granted on CVD and SAD levied on imports which favour imports over domestic production. Under the GST, both will be combined and a uniform IGST will be applied on imports. If any import IGST exemptions are allowed under the GST (to mimic the current CVD and SAD exemptions) that would make a mockery of the PM’s Make in India initiative.

In conclusion, it must be accepted that the GST suffers from weaknesses largely related to the exemption of so many items from its scope: alcohol, petroleum, electricit­y, land and real estate, health and education. But warts and all, the GST has been a great achievemen­t and worth having not least because of being a daring experiment in the governance of cooperativ­e federalism. It would be curmudgeon­ly not to acknowledg­e this first-order fact. But in order to minimize the damage from these warts, at least the structure of rates on those products not excluded should be low, simple, and efficient.

In politics, it is asserted, and rightly so, that the best should not become the enemy of the good. At the same time, politics must yield outcomes that are passably good otherwise they are not worth having. Can the GST Council, at this constituti­onal moment, deliver such an outcome?

The country will be watching, oscillatin­g between hope and anxiety.

This is a constituti­onal moment for the GST, a moment ripe for ambition and visionary decision-making which must be seized because it comes “but rarely in history” The GST cannot be burdened with the task of meeting other objectives such as employment, industrial policy, and social engineerin­g

 ??  ?? If a product goes from being exempted today and attracts a GST rate of 5 per cent, it could well be (as in the case of many agricultur­al products) that there has been no increase in the consumer’s actual tax burden
If a product goes from being exempted today and attracts a GST rate of 5 per cent, it could well be (as in the case of many agricultur­al products) that there has been no increase in the consumer’s actual tax burden
 ?? ARVIND SUBRAMANIA­N ??
ARVIND SUBRAMANIA­N

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