GST rate rationalisation: The larger objective

In a separate chapter on the Goods and Services Tax (GST), the Fifteenth Finance Commission suggested a merger of the 12 per cent and 18 per cent GST slabs into one slab (perhaps 16 per cent). This recommendation spurred the government’s efforts in this direction. The Finance Minister announced that the GST Council could consider this at its next meeting.

The slab merger exercise should not only be limited to a reduction in the number of slabs but should form part of a larger exercise to raise the current 11.8 per cent incidence of GST duty to a revenue neutral rate of at least 14 per cent. The Fifteenth Finance Commission alluded to this, saying that a significant proportion amounting to 2.2 per cent of revenue potential was lost. This principle of revenue rate neutrality was followed in fixing rates in the first year after the implementation of GST, which resulted in an increase in the tax buoyancy rate to 1.20. Later on, this principle was jettisoned.

Besides merging the rate slabs of 12 per cent and 18 per cent, the GST Council could consider phasing out exemptions to those commodities that were subject to VAT duty by the States. Prior to the implementation of the GST, there were roughly 290-plus Central Excise exemptions and 90-plus state VAT exemptions. During the deliberation, it was decided that only 90-plus state VAT exemptions should be retained and the rest could be brought into the GST duty net. This will be a useful principle to bring many of the currently exempted items under the 5 per cent merit rate.

The other suggestion is to abolish the 3 per cent special rate prescribed for gold and gold jewellery, and bring them to the 5 per cent level. This move was earlier debated and former Finance Minister Arun Jaitley had then stated that if items like soap could be kept at 18 per cent rate slab, gold and gold jewellery could also be placed at a 5 per cent GST slab. But the rate was finally fixed at 3 per cent because of the consensus at that time. The case for a higher 5 per cent duty on gold and gold jewellery is fortified by the National Sample Survey (NSS) data and the GST Committee calculation, which shows that the top 20 per cent of the population categorised by income accounts for nearly 80 per cent of gold consumption and the bottom 20 per cent of the population by income consumes just 0.6 per cent. This measure, therefore, could be justified on the grounds of equity.

The Council could also look at increasing the duty on unprocessed tobacco from the current rate of 5 per cent to the merged rate of 16 per cent (currently, the duty on this product is levied on reverse charge basis in the hands of the dealer). This measure would help in looking at tobacco taxation in general instead of being fixated on cigarettes only. Today, out of 420 million kg of tobacco produced, about 72 mn kg (flue flavoured tobacco) goes into cigarette manufacturing, while the rest goes into the making of other tobacco products. To the extent tobacco goes into the making of exempted tobacco products, the government would gain revenue.

The measure to raise duty on unprocessed tobacco from 5 per cent to 16 per cent (suggested merged rate) would also help in establishing the principle of taxation as an instrument to curb consumption of tobacco products. This measure will also help to reduce misclassification due to the current duty arbitrage of 5 per cent on unprocessed tobacco and 12 per cent on processed tobacco.

Finally, the Fifteenth Finance Commission has also suggested a band of 28 to 30 per cent as a demerit rate. The Council could raise the rate to 30 per cent plus Compensation Cess, which is already being levied. Once the Compensation Cess goes, this rate could go up to 40 per cent.

The changes suggested could lead to a three-tier rate structure in the medium run comprising 5 per cent, 16 per cent and 40 per cent, which is broadly in line with the rate structure recommended by the GST Committee in its report on Revenue Neutral Rate released in December 2015.

On the petroleum side, now is probably not the appropriate time to bring in all the petroleum products within the ambit of GST as it would deprive the States of some fiscal flexibility. However, to begin with, the GST Council could recommend bringing in natural gas and aviation turbine fuel (ATF) within the GST net. Natural gas is largely an intermediate input. Bringing ATF would help in setting off input duty against the GST levied on aviation output services.

To sum up, the GST rate rationalisation exercise is timely as it can be done in a manner to ensure revenue neutrality of overall rate, which was the guiding principle announced at the time of the implementation of GST.

On the petroleum side, now is probably not the appropriate time to bring in all the petroleum products within the ambit of GST as it would deprive the States of some fiscal flexibility