Fixing GST rates for 6 remaining items will be challenging; here's why

The Goods and Services Tax (GST) Council on Friday concluded its 14th meeting in Srinagar, Jammu & Kashmir, and there now are five broad messages coming out loud and clear.


The first message: While commendable progress was made in Srinagar by fixing rates of more than 1,200 goods and 500 services, a few more politically significant issues still remain to be sorted out. That is not going to be easy. Remember that just about 40 days are left before the planned GST rollout from July 1, 2017.


Fixing the six rates


Fixing the rates for six politically sensitive items will be top on the GST Council’s agenda for its 15th meeting to be held in New Delhi on June 3, when only 27 days would be left for the GST rollout. The items whose rates would have to be fixed – by consensus among all states, as has been the convention followed by the Council so far – are gold, textile, agricultural implements, bidis, footwear and bio-diesel.


All these items have strong political constituencies and it would require Finance Minister Arun Jaitley to invest his considerable political capital to ensure that the rates are neither ridiculously low nor politically unacceptable. A lot of attention would be focused on bidis, as the powerful tobacco lobby, already stung by a hefty GST rate plus a huge amount of cess, would try hard to see that bidis do not get away easily.


Similarly, the duty on agricultural implements will also be the bone of contention as these are used by farmers and the question Jaitley would have to answer is why items of a farmer’s use should not be taxed at the lowest rate, if not exempted completely. Gold, textile, footwear and bio-diesel would also be debated intensely by the members of the GST Council before a decision on their rate slabs is taken. The textiles and footwear sectors are hugely employment-intensive and widely dispersed across different states as small and medium enterprises. Once again, difficult choices will have to be made and the process would not be without intense debate and even a few controversies.


The contentious nature of these six items can be gauged from the fact that the GST Council at its meeting on Thursday had failed to arrive at a consensus on their rates and hoped to find a solution the next day. But the desired solution remained elusive even on Friday, forcing the Council to defer its decision to June 3.


Composition resolution


Yet another issue that needs to be resolved at the next GST Council meeting is about the rules on composition, which would lay down terms for allowing settlement of disputes over claims of input tax refund and any other matter with the revenue department or other traders. The rules on valuation, transition, input tax credit, invoice debt and credit notes, payments, refunds, registration and returns have been framed and adopted by the GST Council. But the rules with regard to composition will be keenly watched, as this would be the key to preventing denial of input tax credit as a consequence of some delinquent traders not uploading their transactions on the GST Network.


It, therefore, remains to be seen if New Delhi can be as productive and fruitful as Srinagar.


Inflation a bigger concern


The second important message coming out of the two-day GST Council meeting that ended on Friday is how the goal of reining in inflation has become an overriding factor in determining the rates for different goods and services. Caution on this front has guided the logic of these rates instead of the larger economic policy imperatives of presenting a more reformist and forward-looking GST rate structure. With many rates (five rates, not counting the zero rate and the cess to be levied on the peak rate of 28 per cent) and many exemptions, the GST to be rolled out on July 1 will have many such imperfections.


The Srinagar meeting has now made it clear why the Union government accepted multiplicity of rates and exemptions as part of the GST regime. The presence of many rates has now allowed the GST Council to juggle around items to bring them under slabs that would help rein in inflation. Taken together with another imperfection in the GST – the provision on penal action against businesses and traders indulging in profiteering in the wake of the GST rollout – the Union government’s primary focus has become clearer. It wants to roll out a tax reform like the GST, but not at the cost of inflation, which can be politically risky.


Thus, items of use by the middle-class Indian have not only been placed at one of the two standard rates (12 per cent or 18 per cent), but they will effectively attract a lower duty under GST than the combined incidence of various duties on them at present. Hair oil, toothpaste, soaps and cereals are among the items that would have a lower GST incidence than their current duty burden. Coal, used for power generation, will also attract a lower GST rate than at present by way of taxes. Even with respect to services, non-air conditioned restaurants, railway travel, taxi aggregators and economy-class air travel (remember that the Modi government has launched a regional air connectivity scheme to cover passengers from smaller towns), the GST rate for them would result in a lower tax incidence than what these services are currently paying out.


A mixed bag for the middle class


The new GST rates for some sectors, however, can upset such calculations. The GST rates for mobile handsets, white goods (mainly television sets, refrigerators, washing machines, vacuum cleaners and air conditioners) and cars will now be higher than their current rates. All these are also being consumed by an increasing number of middle-class Indians living in cities, as also in smaller towns and even villages. Given their weights in the revised Wholesale Price Index and the Consumer Price Index, a higher incidence of GST on these items could raise prices, though the government would try to ensure that there are no price rises on the ground that a higher tax incidence would now be offset by refunds of taxes paid on their purchases of raw materials and components. Similarly, higher GST rates for financial services, telecommunication services, five-star hotels and air conditioned restaurants could put some pressure on prices. 


Boost to investment


The third message is in how the GST rates have been tweaked to encourage investments in the economy. Items falling in the capital goods sector have been placed under the 18 per cent duty slab which essentially means a reduction of 10 percentage points from the existing rate of about 28 per cent. This, along with the advantages of duty setoff the capital goods manufacturers can claim on taxes they pay on the purchases of their raw materials and components, would result in a substantial benefit for the makers of mother machines in the Indian economy. A government that has been trying hard to revive investments has finally taken a decision through GST that should provide a fillip to the capital goods sector.


A maze of rates


The fourth message is a little sombre. The government has stated that almost 81 per cent of the items have been classified under rates of 18 per cent or below. This means that only about a fifth of the items will attract a rate of 28 per cent or above. But break this down further, what you get is the following: About 60 per cent of the items are under 12 or 18 per cent tax bracket, about 21 per cent are placed at five per cent and 19 per cent at 28 per cent or above, inclusive of the cess. If not corrected soon, such multiplicity of rates can be an invitation to more lobbying by vested interests to seek preferential treatment and even to corruption.


A similar maze has been created for services with four slabs classifying over 500 items. There are instances of services like the hospitality sector, where hotels have been classified under four different rates. This is perhaps just the beginning, as subsequent lobbying for securing a more favourable abatement rates for different services is yet to begin. That would increase the effective rates for services to more than the currently proposed four. The sooner the number of these rates are reduced, the better will be the chances of restoring the desired stability, integrity and efficiency to the GST regime.


Illogical exclusions


The fifth and final message is about the illogic of excluding some goods and services from GST. Real estate is already out, perhaps because the newly introduced real estate law has already unnerved the sector. Including it under the GST at this stage might have upset the industry further and undermined the government’s attempts at securing enthusiastic and whole-hearted participation in its programme on affordable housing. But why exclude health care and education services from GST? If advertisements in newspapers could be included, why not health care service providers and educational institutions? The exemption of foodgrain can be understood, but excluding many other goods in the past (alcohol, some petroleum products, etc) is going to distort the character of GST. Exclusion of health care and education from GST regime will eventually hurt these sectors as they would be denied the benefit of setoff of taxes they pay on their purchases. Thus, instead of being a relief, the exclusion of health care and education is a setback for the two sectors.


Three worry points for the future


So, what does the future look like for GST? One, the pressure on postponing its rollout to September 1 is likely to increase, as many medium enterprises will take longer time to internalise the new rates announced on Friday and update their databases on their respective computers. One of the items on the agenda of the June 3 meeting will certainly be whether it makes sense to postpone the GST rollout by two months.


Two, the GST Council will have set a time table for reducing the number of rates over the next couple of years. Without reducing the current multiplicity of rates, the benefits from the new tax regime would not be as much as it can potentially yield.


And three, if the GST rollout can indeed rein in inflation over the next six months to a year, what implications it would have on the government’s stance on the monetary policy trajectory? The pressure on the Monetary Policy Committee to ease rates would only grow if there is no substantial pressure on prices after the rollout of the GST. But for that to happen, one has to wait and see if the GST is indeed rolled out in July and whether prices remain under control after that.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.

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