Next big challenge: Moderate taxes

The passing of the 122nd constitution amendment bill by Rajya Sabha last week may have eased the process of introducing Goods and Services Tax (GST) sometime next year, after the bill is passed by the required number of state legislatures, but its positive impact on economy will principally depend on a centre-state agreement to keep GST rates at moderate levels – say, below 18 percent on an average -- to drive domestic demand, consumption and to expand market, increase production, raise economic growth and improve tax compliance. The GST must expand the market to boost the economy.

The expansion of domestic consumption will automatically lead to higher tax collection, benefiting both the centre and states. High rates of indirect tax under GST will choke the demand and consumption. Even luxuries need not be highly taxed to make them the preserve of only the super-rich. The consumer base in each segment must grow, including those for aspiring super rich. Otherwise, there will be little incentive for the domestic production of such items of consumption restricted by price for only the reach of the super-rich. Those items will be imported denying possible domestic production to serve both the local and export markets and diminish the government’s “Make in India” effort. Moderate rate levels will make GST a success from the very beginning and keep the inflation rate within the government’s latest target of 4-6 percent.

However, states seem to have their own agenda concerning GST rates. Some of them are against moderate GST rates, which, they fear, may eat into their own annual revenue expectations and development spending. This is despite the fact that the Union government has assured the states full compensation for five years for any revenue loss. But, states are still worried about funds to spend adequately on health, education, and other crucial development schemes. Not many are willing to increase their borrowings to cover fiscal deficit.  Naturally, they want more.  

Maybe, there also exists a trust deficit between the Centre and states. Or, there could be doubt about the GST compliance level in view of the fact that the number of habitual tax offenders has only grown over the years. And, indirect tax administration of both the Centre and states is among the most corrupt bodies. Unfortunately, both the states and the Centre do not quite admit the logic that higher GST rates may lower their compliance, as it has been always experienced, benefiting dishonest individual tax administrators more than the tax administration. GST, along with the government’s latest drive for financial inclusion and cashless transactions, should act as a part of major combined initiative to substantially reduce trade and economic corruption the country. During a recent state-level discussion on GST rates, it was found that some northern states currently levy taxes combining as high as up to 28 percent, including VAT, entry tax and others. 

Some of them want the standard GST rate should be around 23 percent. In fact, Kerala’s Finance Minister Thomas Isaac had reportedly wanted the standard GST rate to be fixed at 24 percent during the meeting of the Empowered Committee of State Finance Ministers on July 25. Isaac strongly opposed the Congress party’s demand to cap the overall GST rate at 18 percent. Despite the statements made last week by the Union Finance Secretary Ashok Lavasa, Economic Affairs Secretary Shaktikanta Das, and Chief Economic Advisor Arvind Subramanian that GST will follow moderate rates having practically no impact on inflation, bigwigs in the BJP party are believed to be in favour of an average rate of 20 percent. This is a cause for concern. The political parties and administration, both in the Centre and states, don’t seem to appreciate the fact that lower direct and indirect taxes since the 1991 economic reform have significantly expanded the market and government’s annual tax revenues over the years.

Being an international economist, Subramanian himself does not seem to be much in favour of high GST rates. A panel headed by him last year had suggested 17-18 percent “standard” GST rate for most of the goods and services while recommending 12 percent for “low rate goods” and 40 percent for demerit goods like luxury cars, aerated beverages, chewing tobacco such as pan masala and manufactured tobacco. For precious metal, it recommended a rate ranging from two to six percent. 

The Subramanian panel had pegged the revenue neutral rate at 15-15.5 percent.  The Chief Economic Advisor feels that a standard rate higher than 18-19 percent will stoke inflation.  He is rightly concerned that an increase in GST rate by a percentage point may reduce its compliance by the same margin. The government seems to have changed its earlier perception on the standard GST rate and inflation, probably under pressure from states, including those ruled by BJP. It now says even if the standard GST rate becomes 20 percent, it would have no average impact on inflation. The next rounds of dialogue between the centre and states and in the GST Council are very important for the achievement of the desired goal behind GST.

The constitution amendment bill does not provide the GST rates and the GST Council. The latter will be formed with representatives of both the centre and states. Subsequently, there will be legislations on Central GST (CGST) and integrated GST (IGST). The government is trying to hurry up the process. The BJP-governed states may summon special Assembly sessions to pass the constitution amendment bill before the next session. It is still not clear if other states will do the same or wait for the next regular Assembly session to take up the issue. The Union government is, however, very hopeful to take up the matter of CGST and IGST in the coming winter session of Parliament. Until then, the GST rates may remain as a matter of speculation.