The second part of a 6-part series on GST
Of all the controversies surrounding the game-changer design of GST, none is as fundamental as the one about the GST rates. A common feature of the successful models of GST in other countries is a single and low rate of tax at the time of its introduction. Japan and Singapore introduced their GST at 3 per cent, and New Zealand and Australia at 10 per cent.
The GST rate in India need not be outside this range. A rate of 10 per cent or less would be sufficient to replace the Centre and state revenues under the current system, and create room for further growth through higher rates in future. It would encourage voluntary compliance and obviate the need for exemptions or lower rates for essential commodities. This would mean simpler tax design, elimination of classification disputes, and lower compliance costs — a win-win for taxpayers and governments.
If the rate does prove to be inadequate, it could be increased later, based on actual revenue performance.
While both the Centre and the states agree that the GST rates have to be revenue-neutral, views diverge as to the level of those rates. The GST task force of the Thirteenth Finance Commission estimated the revenue-neutral rate to be five per cent for the Centre and six per cent for states, if applied to a comprehensive base of all items in the consumer basket. (The task force had recommended a higher state GST rate of seven per cent, to accommodate revenues need of municipal and local governments.)
These rates were based on the assumption that GST would replace all the domestic indirect taxes, other than those on petroleum, alcohol and tobacco. If the stamp duty and levies on vehicles, goods and passenger transportation, and electricity, were not to be subsumed under GST (as the states have argued), the revenue-neutral state GST rate is reduced to 3.8 per cent, for a combined Centre and state rate of less than nine per cent.
The task force calculations have attracted some controversy. Both the Centre and the states fear these rates might not be adequate to replace their revenues. While they have not proposed any specific alternative rates, suggestions have been made for a combined tax rate in the range of 16-18 per cent.
Such a high rate would seriously compromise the simplicity and efficiency of the GST design. They would create a vicious circle of base erosion through exemptions and multiple rates, increased complexity, and lower compliance — all leading to yet higher rates to meet the revenue goals.
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Overall, the higher rate may yield no more revenues than the lower rate. Ironically, this could be taken as vindication of the skeptics of the lower rate.
The task force has computed the GST base through several alternative methods, which yield similar results. The method which appears to be the most robust is the one based on the sales and purchases actually reported by the universe of 2.85 million businesses on their income tax returns filed electronically for 2007-08, yielding a GST base of Rs 30.7 lakh crore. Given the tendency for under-reporting of income, this would be a conservative estimate of the base. Further, any resulting upward bias in the calculations is more than offset by the task force not making any allowance for the gains from improved compliance and higher GDP.
Some states are concerned that even if a single uniform rate is revenue-neutral in aggregate for all the states, it might not be for each of them individually. There would be states with losses and gains. If the gains/losses are modest and temporary, they could be addressed by the assurance provided by Finance Minister Pranab Mukherjee to compensate the states for revenue losses in the initial years. However, if they are significant and enduring, one could consider increasing the Centre GST rate by, say, one percentage point, and earmark the incremental revenues to a special fund to provide compensation to the states for any shortfall in their revenues. This would preserve inter-state uniformity of the GST rate, while at the same time ensuring that no state suffers a revenue loss from GST.
The author is partner, Ernst & Young. Views expressed are personal.