Perfecting the GST

The goods and services tax (GST) is now a reality. The GST might be imperfect, but it remains the best hope of knitting India together into a single market. We need to welcome it — but also to agitate for its improvement, and to stand ready to remedy its deficiencies and ill-effects.

As it stands, the GST dearly and desperately needs improvement. To see why, let’s try and compare it with the “ideal” GST — in other words, the one we were promised when the idea was first floated. 

That GST was simple — enticingly simple — and correspondingly powerful. It suggested a single tax rate, or at most a narrow band of rates; a reduction in paperwork; and a reduction in the overall tax rate paid for by the expected increase in total tax revenue.

None of these conditions has been met. Definitely not in full, and only some in part. Consider first the idea that there should be a single tax rate. Instead of this we have been left, thanks to the political bargaining between states and parties — and also thanks to some judicious lobbying — with a plethora of tax rates, five or six depending on how you count. Food in a restaurant, for example, can be taxed at any of four rates from 5 per cent to 28 per cent, depending on various factors such as air-conditioning and the star rating of the hotel the restaurant is in. Why is this a problem? First, it is not simple to administer. Second, it leaves the door open for taxpayers to evade taxes by moving revenue from one head to another head with lower taxes. Third, it opens up the possibility for rent-seeking, as various industries and sectors clamour for lower tax rates for their particular products or services — some of which, according to reports, has already started happening. 

Then look at the second condition I originally mention, the question of paperwork. Ideally, you should not be forced to submit monthly returns. Some major indirect taxes are currently collected quarterly, and that should have been the expectation for the GST. In Australia, for example, only very large companies have to pay the GST monthly; smaller companies can pay the GST quarterly. In India, this benefit is possible only under the “composition” scheme, in which smaller companies can’t claim input credits. In the current GST, a taxpayer has to submit three returns a month for every single state it’s in. Some of these are “auto-populated” — but that’s not as much of a relief as all that, for you’re still liable for any errors in them. As one tax expert told the news service India Abroad: “Though inward returns and monthly returns will be auto-populated, the taxpayer will still have to validate these details before submission and add additional information like GST paid under reverse charge mechanism, details of credit notes etc.” 

The idea should have been that all but the largest taxpayers have to produce at most four or five returns nationally. As it stands, the strong dis-incentive for small firms to expand beyond a single state remains. This was one of the crucial reasons why the early GST was a great idea, and it has been lost in the current conception of the tax. Partly, this is to placate the indirect tax bureaucracies in the various states — a terrible motive if ever there was one. 

Finally, what of the overall tax rate? It is possible that many staples will not be taxed at a higher rate than earlier — in fact, controlling or reducing the tax rate on goods that comprise the bundle from which the Consumer Price Index is calculated seems to have been a primary objective. This might help the government sell the reform to voters — “Look, inflation has not gone up according to the numbers!” But if the prices of other goods go up, voters won’t be fooled. More to the point, it is far from clear that this GST will have the silver bullet effect that the “pure” GST would have provided. That would have both reduced the incidence of tax on the honest and increased government revenue. In the current form of the GST, however, the effect on total government revenue is uncertain, while the effect on private consumption, investment and production is emphatically not going to be the immediate boost that a flat, lower rate would have provided. 

Illustration by Ajay Mohanty
It is to be hoped that the GST Council is aware of these problems; and that the central government, in particular, recognises that its responsibility does not end with the introduction of an imperfect GST. It has to keep on building a political consensus for improvements to the GST, while keeping this “ideal” GST in mind as the target. As comfort grows in the broader political class with regard to the changes that the GST will wreak, these reforms should be introduced into the actual GST through rulings and changes mandated by the GST Council. In other words, the work is not over, so the government should stop patting itself on the back. 

The government also needs to be on the look-out for the various problems in implementation that are inevitably going to arise — as well as other, more serious problems inherent to the GST. 

For example, the effect on small and medium enterprises should be carefully gauged. SMEs were the drivers of a nascent growth revival about a year ago; but the investment crunch turned that into a slowdown and then demonetisation hammered SMEs still further. Now their compliance and working capital costs have been increased at a stroke — which was, again, certainly not the intention of the original GST. Their demands will need constant attention. 

More broadly, the concerns of certain states about their tax revenue should be carefully kept in mind. The current system has one major benefit: It allows states to raise or lower indirect taxes, and thereby control their own spending-taxation choices. State governments’ degrees of freedom have been reduced. That may have deleterious political effects in the long run if efforts are not made to ensure that they still have sufficient room to manoeuvre in response to local political demands. 

As problems, gaps and imperfections in the GST are brought to its attention, the government will need to be open to these complaints, and not dismiss them as the ravings of the corrupt. In order to make this vast reform a success, a government that both listens and acts will be crucial.
Twitter: @mihirssharma

Business Standard is now on Telegram.
For insightful reports and views on business, markets, politics and other issues, subscribe to our official Telegram channel