GST revenues take a beating as Council tweaks rates far too often

Centre to propose one a year tweaking; states say proposal is not enough, slabs need to be changed, experts call for flexibility to cater to immediate needs

According to the government's own admission, Rs 1.10 trillion out of the expected Rs 2.35 trillion shortfall in compensation to the states for implementation of the goods and services tax in the current financial year is due to the gaps in the existing GST system. 

The Centre paid compensation to the states from the cess levied for this purpose in 2017-18 (July-March) and 2018-19. However, the compensation cess could not collect the required amount in 2019-20 and became a major bone of contention between the Centre and the states in the ongoing financial year. 

While there are many reasons that cess collections fell short of the requirement, including slowing down of the economy, the frequent rate cuts could also be blamed for this. The rate cuts slowed down the revenue collections projected at the beginning of the rollout of GST in July 2017.

In fact, the rate cuts introduced on a number of consumer durables in July 2018, without the recommendations of the fitment committee, aggravated the revenue situation when the economy slowed down the following year. 

To address the issue, finance minister Nirmala Sitharaman recently stated that she would take a proposal to tweak tax rates once a year to the GST Council in line with the budget. 

She said 2019-20 and the ongoing financial year were extraordinary, as the compensation cess failed to meet the requirement of compensating states due to its inability to achieve the projected 14 per cent annual growth with 2015-16 as the base year.

Other than Covid and the economic slowdown, there is the issue of how frequently a rate reduction or increase ought to be implemented, she said. 

"I am requesting the Council not to decide the rate change in every meeting," the finance minister said. "Changing the rates in either direction upsets the calculation of your revenue generation. These are the things which are germane to the revenue generation and compensation collections." 

Sitharaman said if GST rates can be tweaked once a year like the Budget, there would be predictability. "I am sure the Council won’t hesitate to discuss this and take a call on the matter," she added.

However, Punjab finance minister Manpreet Singh Badal said that the whole GST structure needs to be redesigned and rationalise slabs to just two. 

“There is something wrong with our GST design. Unless you rectify the design, revising the rates once, twice or thrice will be meaningless. We need to fix our rates, rationalise slabs,” said Badal. 

He added that unless GST slabs are cut to two maximum, it will not help. 

"Look at the number of rates we have, look at the exemptions that we have given. It is the most complex GST in the world,” Badal said.

He added that Punjab and the Congress party are proposing a GST 2.0. “Let’s take a holistic view and fix it so we don’t have to fix these rates ever again. Not even once a year. You can do either 10 per cent or 20 per cent or 5 per cent and 18 per cent. That can be worked out,” he said.

Currently, GST has four slabs -- five, 12, 18 and 28 per cent. Over the peak rate, there is cess on demerits and luxury items. Besides bullion is taxed at less than five per cent. 

Kerala finance minister Thomas Isaac, on the other hand, batted for an upward revision in GST rates to ensure states don’t face revenue shortfall once they stop getting compensation post June 2022. 

“I agree that we shouldn’t be tinkering with rates in every meeting. But now, we need upward revision of rates so there is no precipitous fall in revenues of states when compensation will not be there. Now the states are not very bothered about rates as they are assured of 14 per cent growth. The Centre has had its say in reducing rates to unremunerative levels,” said Isaac. 

M S Mani, partner at Deloitte, said frequent changes were required in initial years because the GST system was yet to be stabilised. 

"With around three and a half years, rates could now be tweaked once or twice a year. However, there should be flexibility to change the rates in between to cater to some immediate needs, say some sector requiring immediate boost or even for the compensation requirement of the states," he said. 

Harpreet Singh, partner, indirect tax at KPMG, said while tweaking GST rates once a year may somewhat limit the government’s maneuverability to respond to special situations such as emergency, geo-political scenario, pandemics, sharp fall in sectors and the like, the same is likely to bring cheer to industry as it allow companies to be better prepared and reduces the effort and costs in changing ERP, packaging, discount policies, rate masters etc. 

India Ratings chief economist Devendra Pant said regardless of the rates or policy adopted, there should be stability and a clear cut roadmap.

"Suppose you have decided that rates will be tweaked in April only. You will have information on revenue projections. But if you again cut rates in May, there would be revenue loss," he said. 

In the very first month of GST implementation, that is, July 2017, the Council decided to raise the compensation cess on cigarettes. Though the cess collection rose, it showed ad hoc nature of the rates. 

Next month, the GST rates were reduced for job workers in the textile sector and tractor parts. In September of that year, 40 items saw cuts in GST rates. Also, compensation cess rates were raised for the auto sector. The next month, 27 items witnessed cuts in GST rates. 

In November of that year, ahead of the Gujarat assembly elections, the rates were pruned for over 200 items. Then in January 2018, rates were cut on over 20 items, while compensation cess was pared on three items, including ambulances. 

Till now, the rates have been tweaked on the recommendations of the fitment committee, which consists of officers of the Centre and the states. They calculate their impact on the GST collections and make recommendations. 

However, in July 2018, the rates were reduced on about 39 items, including consumer durables such as electrical appliances, TV sets up to 68 cm, refrigerators, washing machines, vacuum cleaners etc. 

After that, rates were not as frequently tweaked. However, they were reduced in July 2019, September 2019 and March 2020. 

These are not the only factors that affect compensation cess. The compensation requirement became such a huge problem that the Council had to discuss the ways to compensate states in a number of meetings without coming to any conclusion. In the end, all states and union territories agreed to one of the options given by the Centre to borrow on behalf of the states through a special window to the extent of Rs 1.10 trillion. Above that, the states will get unconditional leeway to borrow up to 0.5 per cent of their respective GSDP from the markets. This provision is still contentious as some states want the Centre to borrow this portion as well and distribute it to states. 

The compensation cess of Rs 51,046 crore was collected in the first eight months of the current financial year, which was 18.43 per cent lower than Rs 62,586 crore in the corresponding period of the previous year. However, previous collections by the government grew quite faster than expected. Earlier in August, the government had estimated that only Rs 65,000 crore would be collected from the cess in the entire financial year. This, coupled with the recent surge in overall GST collections may bring down the requirement of compensating the states, originally pegged at Rs three trillion, of which Rs 2.35 trillion was to be shortfall in the cess. 

In fact, collections were muted in the last financial year too. The collection was Rs 95,000 crore but states were given Rs 1.65 trillion after dippin