GST rationalisation: Challenge and response

A revision of slab rates may create some disquiet, but, if cleverly crafted, it could be a game-changer for manufacturing

The goods and services tax (GST) journey like the Sagar Manthan has seen the toxins of transitions yielding to the nectar of higher revenues, demonstrating that there is nothing wrong with the design of this transformational tax regime. The recent buoyancy of GST revenues has been aided by better compliance and a rapid recovery of the formal manufacturing sectors.

With the GST revenue settling down, the creation of the group of ministers (GOM) by the GST

Council for rate rationalisation and correcting the inverted duty structure is both timely and appropriate. The GOM has the very difficult task of balancing a number of objectives. The most important being to raise the average incidence of duties from the current level of 11.8 per cent to about 14 per cent (revenue neutral rate) as suggested by the Fifteenth Finance Commission. The other objective of course is to make the whole process non-inflationary while also giving a boost to labour-intensive manufacturing.

In my view therefore, the GST rate rationalisation exercise must not look at it purely from the narrow prism of revenue but also keep an eye on the larger macro economy.

First of all, to keep the whole process non-inflationary, the standard GST rate must be brought down from 18 per cent to 16 per cent. This will especially benefit the services sector, which now bears the primary responsibility of creating employment. However, to do this, the rates at the extremities of the GST rate spectrum have to go up. For example, there is a strong case for phasing out a lot of exemptions, which is in line with the recommendation of the Committee on Dual Control, Threshold and Exemptions. This Committee recommended that only the state VAT exemptions prevalent in the pregst era be retained while phasing out many of the erstwhile central excise exemptions.

These exempted items will have to move to the merit rate. There is a case for increasing the merit rate from 5 per cent to 8 per cent. A large number of labour-intensive manufacturing sectors like textile and footwear that fall under the 12 per cent GST slab can move down to 8 per cent. Keeping them at 12 per cent will carry with them the prospect of raising the rates to 16 per cent when the 12 per cent and 18 per cent rate slabs are clubbed together into a single 16 per cent rate slab. A lower rate of 8 per cent will also complement the recent output incentives granted to textile (synthetics and technical textile) and footwear. Besides, it will also fix the inverted duty problem for both the segments.

This alone is not enough. The import regime has also to be changed as it has become too protective in the last few years. The average import tariff rates have gone up from 10 per cent to 18 per cent. This is hurting industry. The current policy view that we must raise exports and reduce imports is not a good and feasible policy. Exports growth requires cheap imports of critical raw materials. A recent study by Arvind Subramanian and Shoumitro Chatterjee showed that the import content in the total value added in the textile sector was 40 per cent for China, 46.1 per cent for Vietnam and 16.4 per cent for India.

At the other extremity of the GST rate spectrum, the peak rate of 28 per cent-plus cesses must move to 30 per cent-plus cesses. To cushion the impact of this increase, two-wheelers could be brought under the 16 per cent rate slab. Two sectors will have to be tapped in order to raise the revenue weighted average GST incidence. This would require revisiting of GST rate on gold, which is now at the special rate of 3 per cent. With 80 per cent of gold purchases and ownership being concentrated within the top income decile of the population, there is a case to raise this rate to 5 per cent. This could be justified if the merit rate moves to 8 per cent. In the case of tobacco, the present GST rate is 5 per cent for unprocessed tobacco levied under the GST reverse charge mechanism. This GST rate could move towards the general tobacco rate of 28 per cent, as there is at present a lot of mis-declaration of processed tobacco as unprocessed. Further, this measure would also garner more revenues for the government to the extent unprocessed tobacco finds direct use in the exempted downstream tobacco products.

The inclusion of petroleum was debated in the recent GST Council meeting held at Lucknow on September 17. The states are perhaps right that this is not the appropriate time to bring petroleum under the GST net. The measure could probably be considered when international oil prices soften in the future. As a start, we could bring aviation turbine fuel (ATF) and natural gas into the GST net. With the aviation industry facing a difficult time, bringing in ATF under GST will help.

Finally, there are two other segments which need to be brought under GST — electricity and real estate. Both will help to clean up the factor market. But their inclusion will require a serious dialogue with the states because a substantial amount of their revenues are involved.

Broadly, the suggestions made for GST rate rationalisation — fewer exemptions/8 per cent/16 per cent/30 per cent-plus cesses (moving to 40 per cent without cesses) with upward tweaks in the rates for gold and unprocessed tobacco — may create disquiet in certain quarters, but as the prime minister has said, no policy change can make everybody happy. The best policy is probably one that minimises unhappiness.

To sum up, if the GST rate rationalisation exercise is cleverly crafted along with concomitant changes in the import tariff regime, it can spark off a revival of manufacturing especially in the labour-intensive segments. This is important when a job crisis looms large.