Data analysis and GST policy

The tax reform's happy ending hinges on appropriate policy reforms, which require mining the rich vein of GST data for deeper insights by research outfit

Data, it is said, is the new oil. One can argue that data is the nectar that policymakers must drink and digest to make good policy. The recent magisterial study by Arvind Subramanian and his team has brought out the veracity of this assertion on the seventh anniversary of the introduction of the goods and services tax (GST).

One of the findings is that GST revenue performance has been overstated because of considering gross revenues instead of net revenues, given the significant proportion of integrated GST (IGST) refunds paid to exporters (0.7 per cent to 0.8 per cent of gross domestic product, or GDP). Therefore, the GST-to-GDP ratio reached the pre-GST level of 6.1 per cent only in 2023-24. This is a sobering truth. If this had been known earlier, perhaps the GST rate reduction exercise in 2017-2018 and 2018-2019 would have been more tempered, with rate cuts balanced by increases in certain items to maintain revenue neutrality.

The study results bring out one important fact: We have not utilised the rich vein of GST data. It is time now to open this up to all private research outfits and public finance groups in our universities. What are the important areas of research with implications for policymaking?

First, there is the important area of inter-state trade. When GST implementation was debated, it was claimed that by the abolition of entry tax and octroi, the so-called “border taxes”, inter-state trade would increase. The Economist in a recent special report said that inter-state trade as a proportion of GDP rose from 23 per cent to 31 per cent between 2017 and 2021. We need to dive deep into this claim using IGST data and other proxy datasets. It is important to know whether the Indian market has expanded post-GST, and which states have gained.

Another crucial area is the impact of GST on small businesses and the whole process of formalising the economy. Small businesses are not one uniform category, as it is often made out to be. In fact, GST reforms should have boosted the fortunes of all small services companies that would have had the opportunity to utilise blocked credits on taxes paid on capital goods.

While policymakers await this analysis, the question is: How do we bring this “happy ending” to fruition?

First, there is an urgent need for rate rationalisation to improve the buoyancy of GST. The GST study suggests the retention of the cess on “sin goods” by incorporating them within the GST rate structure. The government has constituted a Group of Ministers (GoM) Committee, now headed by Bihar finance minister. The Committee has a difficult task ahead, for it has to balance the twin objectives of maintaining “revenue neutrality” and avoiding “inflationary pressures”. Here are some concrete ideas for the Committee’s consideration.

First, the standard GST rate must be brought down from 18 per cent to 16 per cent. This will be an important signal that the government seeks to bring down the cost for both the manufacturing and services sectors. It is important to recognise that in order to reduce the standard rate, the rate on products at both ends of the spectrum must be enhanced.

For example, the rate on sin goods, which contribute 16 per cent of GST revenue, must go up from 28 per cent to 40 per cent after absorbing the cess. The 12 per cent rate may have to be merged with the 16 per cent slab with certain exceptions for textiles and pharmaceuticals. In the case of pharmaceuticals, the rate can be brought down from 12 per cent to 8 per cent, and for textiles, from 5/12 per cent to a uniform rate of 8 per cent. The special rate on gold and jewellery could go up from 3 per cent to 6 per cent to offset losses from reducing the standard rate.

All exemptions have to be phased out and these goods will have to be placed in the 8 per cent rate slab, except for those goods that were value-added tax exempt in the pre-GST era.

Finally, there is a case for reducing the exemption limit for all units under GST. This may sound counterintuitive, but it needs to be understood that exemptions are “poison not panacea” in the GST universe because they deprive businesses of input tax credits.

One other benefit would be the reduction in evasion, for it has been found that fake invoices are often issued in the name of exempted units. Thus, a three-tier GST structure with 8 per cent, 16 per cent, and 40 per cent slabs with fewer exemptions would boost GST revenues and stimulate manufacturing on the demand side through the reduction in the standard rate.

This rate rationalisation exercise would need to be complemented on the supply side by a restructured tariff policy. It is imperative, as mentioned by all leading economists, that the incidence of Customs duty must be brought down from the present level of 18 per cent to 10 per cent or below. Within this, we could have a three-tier structure with the lowest rate on raw materials/components, a slightly higher rate on intermediates, and the highest for finished goods. This will rectify the inverted duty structure and make available critical raw materials and components to our manufacturing industries. These customs tariff changes can be made in the upcoming Union Budget itself.

The GST rate reforms, if done accordingly, can boost the tax-to-GDP ratio from the present level of 18 per cent to 20 per cent (through a combination of rate increase, better compliance and expanded base). The improved tax-to-GDP ratio will help the government boost its expenditure on priority sectors like health and education.

In conclusion, the GST’s “happy ending” would be possible if appropriate policy reforms are put in place. It would also spark a manufacturing renaissance, especially in labour-intensive manufacturing, provided that foreign direct investment is encouraged to flow into areas like textiles, footwear, light engineering, and food processing. This could create the Maruti moment in these sectors. Only then can we reap the demographic dividend. Our policymakers owe this to the youth of this country.

The writer is former member, CBIC. The views expressed are personal