Raise GST rates, but not without reforms

Avoid past mistakes and reduce the number of GST rate slabs along with rate increases

The launch of the goods and services tax or GST in the whole country in July 2017 and its implementation in the last five-odd years have suffered from many policy mishaps. Obviously, their consequences have been adverse for the new indirect taxes regime. As the GST completes five years of its operation in July 2022, a review of these mishaps would be instructive.

The first mishap took place even before the GST was launched. To secure the support of all the states for the new indirect taxes system, the then finance minister Arun Jaitley had assured them an annual revenue growth rate of 14 per cent from the GST, anything below which would entitle them to a compensation from the Centre for the first five years after its rollout.

Perhaps, that promise could be justified on the grounds that a major tax reform required a special incentive for stakeholders to embrace it. But there is no denying that the promised annual revenue growth rate was on the higher side and has now made the discontinuation of the compensation at the end of five years in July 2022 a major problem.

The Bharatiya Janata Party (BJP), ruling at the Centre, has more than half of the states under its control. Even though the GST Council’s voting system gives the Centre an effective veto against any proposal from the states that it is not comfortable with, the possibility of more than a dozen states politically not aligned with the BJP makes the task of the GST Council in arriving at crucial decisions a little more difficult.

If the discontinuation of the compensation regime is deferred, the blame for this would largely fall on the grand assurance of an unrealistically high annual revenue growth rate for the states. The first lesson, therefore, is: Do not make an unrealistic promise even if it is made for a good cause.

 The second mishap occurred in two instalments — once in November 2017 and then in December 2018, a few months before the general elections of 2019. In retrospect, it appears quite incomprehensible that  even before allowing the revenue stream to stabilise at a steady level of about Rs 1 trillion a month, the GST Council decided to slash rates.

 At its 23rd meeting on November 10, 2017, the GST Council  reduced duties on as many as 94 categories of goods. This essentially meant that the list of goods attracting 28 per cent duty was pruned from 224 tariff headings to just about 50 tariff headings (calculated at the four-digit level) and their new duty was 18 per cent. All the changes led to a cut in duties and not even one item saw its duty go up by way of an overall rate rationalisation.

Illustration: Binay Sinha

 That was not all. About 13 months later, at its 31st meeting on December 22, 2018, the GST Council went in for another round of duty cuts, even ignoring concerns voiced by many state finance ministers about the adverse impact of such duty cuts on revenue collections. At the December 2018 meeting, held five months before the 2019 general elections, the Council slashed rates for another 17 categories of goods. This time too the changes in duties resulted only in a reduction in the rates.

 Forget about reducing the number of duty slabs from five (excluding the 3 per cent rate for gold, etc) to a more reasonable and optimum level of three slabs, there was not even an attempt at rationalising the rates by raising the duty on some items. Guided by the Centre, there was a festival of rate reduction in two tranches, ignoring the  the warning of dire consequences they would have on GST collections.

 In the first four months after the GST launch, the average monthly collections had ranged between Rs 0.93 trillion and Rs 0.95 trillion. After the massive cut in rates in November 2017, they slipped to below  Rs 0.9 trillion in each of the remaining months of 2017-18. In the first eight months of 2018-19, the monthly collections stayed at around Rs 0.97 trillion, with only two months during this period touching the Rs 1 trillion mark. And yet, another rate cut was administered in December 2018.

 The average monthly collection rate in 2018-19 was only Rs 0.98 trillion and the impact of the rate cut was evident even in 2019-20, when the monthly collection rate moved up marginally to Rs 1 trillion. The drop in the monthly rate of GST collection in 2020-21 to Rs 0.94 trillion was understandable as the Indian economy contracted, impacted as it was by the Covid pandemic and the economic lockdown. But the damage inflicted by the rate cuts to the GST collections was far more severe than the havoc caused by Covid in 2020-21.

The obvious lesson from the second mishap, therefore, is that the GST Council should not have gone in for a steep cut in rates on so many items so soon after the new taxation system was launched. Even if it had decided to cut the rates, this should have been accompanied with a reduction in the number of slabs, which would have required some rates to go up. Clearly, it was a short-sighted move and appeared to have been guided more by electoral considerations and less by the need for reforming the GST.

To be sure, India’s GST regime also benefitted from a few pragmatic and sensible moves. The Council had launched the e-way billing system to capture all inter-state movement of goods from April 2018. A more rigorous scheme of e-invoicing was introduced from October 2020 to capture transactions above a certain consignment value. Its coverage got wider over time.

Aided by the general economic recovery, the use of technology to track movement of consignments and transactions through e-invoicing, a more effective mapping of direct as well as indirect tax data and a rise in imports helped the GST collections in 2021-22. The average monthly rate of collections rose to Rs 1.23 trillion. Even though the GST collections’ share in the gross domestic product rose marginally to 6.28 per cent in 2021-22 (almost the same level of 6.22 per cent in 2018-19), the improvement in overall collections has given the much-needed fiscal cushion to both the Centre and the states.

But now the danger is that, even before the gains from the economic recovery and the improvements in collections efficiency have stabilised, the GST Council is attempting another big change in the rates, which if implemented in the proposed manner would be yet another policy mishap. Two ideas are doing the rounds. One suggests that the lowest duty band of 5 per cent should be split into two — 3 per cent and 8 per cent. The other idea suggests raising rates for over 140 items, mostly consumer durable goods, from the current 18 per cent to 28 per cent.

Both ideas are problematic. It is not sensible to raise rates when inflation is already elevated. They are also flawed as they assume that raising rates alone can help the GST Council meet its challenges. The need of the hour is to reform the GST rate structure, not just raise the rates. Reducing the number of slabs to three should be the way out, which would require an increase in a few rates and a cut for many others. The lessons from the past five years should not be forgotten. The Council failed to use the opportunity of reducing the number of slabs when it was slashing rates in 2017 and 2018. If it has to raise the rates now, it must be accompanied with a reduction in the slabs.