GST Needs Wider Net, Lower Rates

The first comprehensive tax reform committee was set up in 1991 under the chairmanship of Raja Chelliah. That committee’s goals were to simplify the tax code, lower the rates and improve tax administration. It also addressed the unfair skew in India’s tax system, wherein the indirect to direct tax ratio was 85:15, which had to go much below 50:50.

A fair tax system requires that a richer person pays more than a poorer person, and that two persons earning the same income, irrespective of the source, roughly pay the same income tax. The journey toward a fair tax system in India is far from complete. Only 2% of India’s population pays non-zero income tax. But almost everyone is subject to indirect taxes. The indirect to direct tax collection ratio is still too skewed. Indirect taxes do not depend on the income of the payer and hence tend to hurt the poor more than the rich. That is why they are called regressive, and unfair.

The Chelliah committee’s road map for reform of indirect taxes was first to move toward a rational value added tax (VAT) which eventually paved the way to the Goods and Services Tax (GST). An important milestone in this journey was the Kelkar Tax Force on tax reforms set up in 2001, which, among other things, had recommended a median rate of 12% for GST, with a simple slab structure. The GST was finally rolled out on July 1, 2017, after nearly three decades of deliberations. It represents a grand bargain between the Union government and states. The states agreed to give up their right to impose VAT, and the Centre gave up its right to impose excise and services tax. In exchange, they share the nationally collected GST. We now have a unified, un-fragmented national market for goods and services, accessible to the smallest entrepreneur. Companies need not maintain artificial stock depots to avoid paying interstate taxes. GST is implemented fully electronically, has interlocking incentives that prevent evasion and leakage and is supposed to have inbuilt buoyancy, in that its collection rises with nominal GDP.

As it nears its eighth anniversary, let’s examine the success of this landmark reform, and what more needs to be done. Firstly, there are 14 million registered GST taxpayers, double of what it was seven years ago. Thus, the net is widening. But of the 70 million micro, small and medium enterprises, not even a fifth are in the GST net. That’s because it is too expensive and burdensome for them. They have to pay tax in advance, and wait long for payment from their customers, especially the B2B enterprises.

Secondly, the annual collection under GST has gone up from roughly Rs 12 lakh crore to Rs 18 lakh crore in eight years, which is much slower than the growth of nominal GDP. This is because the GST Council is under pressure to exempt a variety of items from pressure groups, defeating the very purpose of a comprehensive countrywide GST.

Thirdly, the compliance burden for filers is too high, with more than 55 annual returns, and having to deal with 3,000 pages of legislation and 15,000 pages of circulars and guidelines. Fourthly, thanks to multiple slabs and constant tweaking of which item falls into which slab, there is a huge amount of litigation and disputes are mounting. There is also harassment arising from differences in interpretation. This is happening both for central and state level GST. That is also leading to judicial backlog.

Thankfully, by consensus there is only one appellate tribunal called GSTAT for all national and state level disputes and orders. It is expected to be a modern court and will use case management techniques that are codified in its operational rules and enabled by state of the art and digital technology. Before it gets further mired in disputes and GST collection starts stagnating, some important reforms are needed.

Firstly, we need just two or three rates ideally. A low rate for necessities and a median rate for all other goods and services. The list of necessities should be small, mainly food and medicines, and should avoid a paternalistic approach to classification. Secondly, GST should widen the net by including energy and electricity and move many items from zero or exempt category to the low rate. Thirdly, the median rate should be 12% not 18%. GST is a consumption tax, does not depend on the income of the payer, and hence poses an unfairly higher burden on the poor. It skews the ratio of indirect to direct taxes, which should ideally go below 50:50. A lower rate will make GST fairer, and less inflationary, and will increase compliance and reduce evasion. Fourth, GST enforcement should move aggressively to digital technology, using Artificial Intelligence techniques to detect fraud or evasion. The data captured by the GST network must be made open, with appropriate safeguards to protect privacy, which can then be used by researchers and policy makers for real time assessment of the economy.

The rollout of GST is historic. Its grand success and sustainability require that the tax burden be moderate, its coverage be comprehensive, its administration use cutting edge technology, dispute resolution be swift and fair, and its collection be shared generously with the states in the true spirit of cooperative federalism.

The author is Ajit Ranade, Economist. Views are personal.