Getting GST To Fulfill Its Potential
Repeated modifications and increased exemptions have reduced the effective GST rate to 11.6%, writes Rahul Bajoria.
When the Goods and Services Tax regime was ushered in with a special midnight joint session of Parliament on June 30, 2017, it was hailed as India’s “biggest tax reform”, and on par with the country’s various milestones related to Independence. However, five years in, and in the wake of what has been a tumultuous period of volatility for the Indian economy, one cannot but feel somewhat underwhelmed with the outcomes so far.
GST Has Only Begun Delivering Materially In The Past 18 Months
First, a few positives definitely stand out. Since the implementation of GST, India’s tax base has expanded significantly with the number of tax filings almost doubled, and there has been an improvement in compliance. Logistical efficiency has contributed to this trend, including a faster turnaround of external trade. Moreover, GST has also helped to consolidate India’s indirect taxation system, thereby contributing to a reduction in tax ‘cascading’, thus benefitting India’s manufacturing sector materially.
Still, GST’s promised boost to the tax base and even GDP growth perhaps is yet to deliver fully. In addition, some procedural hurdles linger – such as challenges with filings, technical issues, and a complex dispute resolution mechanism. Furthermore, from a revenue perspective, GST is broadly on par with the taxes it replaced, while being broadly in sync with the tax buoyancy seen in direct taxes as well.
Indeed, overall improvement in collections has been mixed, and the multiple and frequent changes to tax rates stand in contrast to the approach adopted by countries such as Singapore and Australia, which maintain a stable tax regime for an extended period of time, thus broadening the base materially.
State GST And Discontent Among States
While the central government has enjoyed the buoyancy of a higher nominal multiplier, the challenge at the level of the states is nuanced. While at a macro level, GST revenue is split evenly between the centre and the states, there is a clear divergence between producing and consuming states.
While revenue collections in most states have lagged in the past two years given the pandemic, the shortfall has been acute in manufacturing-intensive states such as Tamil Nadu, Maharashtra, and Gujarat. Through 2020 and part of 2021, these shortfalls were being met through both compensation cess borrowings and fuel taxes, but these sources are likely to dry up in light of the changing guaranteed revenue equation.
This is a core challenge for states going beyond June 2022, given that at the aggregate level, we estimate that states are likely to see a revenue shortfall of at least 0.50% of state GDP in FY22-23, which they will have to cover either by reducing expenditure or increasing other sources of revenues.
It is not that the centre is not responsive to this problem. In its budget, the government did include capex-related grants for the states, and in case they face revenue shortfalls, they can always look to tap into this funding source rather than hike duties on fuel or alcohol or housing, items that are outside the purview of the GST for now.
GST Reforms: The Shoe Is On The Other Foot Now
Ironically, the burden of reforming GST now falls on states, and not so much on the centre. Indeed, in the initial years of implementation, states had pushed for material tax cuts in the GST, given they had guaranteed revenues, but now they need to try to raise the effective rate of GST in order to bolster their fiscal position.
Indeed, repeated modifications and increased exemptions have reduced the effective GST rate to 11.6%, significantly below the 15.3% revenue-neutral rate proposed by the Arvind Subramanian Committee in 2015.
This, along with expanding the tax base remains a priority, however, elevated inflation makes it difficult to undertake large increases in GST rates in the near term. While the GST has several rates, the ‘effective GST rate’ or EGR defined as the ratio of GST collections as a percentage of nominal private final consumption expenditures, provides a single value that traces the cumulative effects of multiple changes in GST rates over the years.
Given the significant underperformance of GST tax collections in its early period, we believe that states and the union government will ultimately need to effect the trifecta of reforms – namely, reduce exemptions, simplify the structure and raise the effective GST rate. Undertaking all these reforms requires not only political support but also material coordination within the GST Council.
There is already a discussion that the 12% and 18% tax slabs be merged into one rate, which could simplify the tax structure substantially. Following the methodology adopted by NIPFP’s Sacchidananda Mukherjee in 2021, we calculate that merging the 12% and 18% tax brackets into a 15% standard rate would lead to a shortfall of Rs 41,400 crore per year or Rs 3,450 crore per month.
Ultimately, despite the differences, both states and the centre have found a way to work together in the GST Council. Now that the revenue guarantees are coming to an end, it is even more important for the two sides to find a way to improve and simplify the GST structure, in order to really make it into the ‘Good and Simple Tax’ that it was promised to be. Any revenue buoyancy that comes as a result of operational efficiency and greater compliance will be a win-win strategy for the country as a whole.
Rahul Bajoria is Managing Director and Chief India Economist at Barclays.
The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.