Public finance experts will understandably find many flaws in the three-year plan that Finance Minister Pranab Mukherjee unveiled last week for moving to a single-rate goods and services tax (GST) regime of 16 per cent for the Centre as well as the states. The proposed rate at the end of three years is much higher than the 12 per cent recommended by the 13th Finance Commission as a feasible and revenue-neutral rate under the new taxation regime. Trade and industry, too, had expected a lower single-rate GST, which the government could have achieved with a wider and uniform coverage. The proposed exemption of alcohol, petroleum products and gas from the new regime, and the inclusion of as many as 99 items in the zero-rate category are expected to encourage similar demands from many more sectors, further weakening the revenue base and putting upward pressure on the final GST rate. The single-rate GST is already high at 16 per cent and any further increase under such pressure will be an incentive for tax evasion.
Several other complications are likely to arise from a system that allows two rates to prevail for goods in the first two years of the transition period. The likelihood of raw materials attracting the standard rate and the finished goods carrying the lower rate is strong and this will result in an avoidable inverted duty structure, giving rise to further problems for the exchequer where input credits or tax refunds may exceed output taxes or the final tax incidence. The three-year GST road map is also fraught with many risks as the government will have the challenging task of reducing the tax rate from the 12-20 per cent range, with which the new regime will kick off in April 2011, to 12-18 per cent by next year and finally to a single rate of 16 per cent by April 2013. Fiscal compulsions of raising revenues to bridge deficit during this period can put undue pressure on the Centre or states to either phase out the transition to the single-rate regime or even raise the final GST rate.
However, it will be naive to assume that a fundamental reform like the introduction of GST in the kind of a federal structure that prevails in India is achievable without making small compromises with various stakeholders, particularly the states where the political parties in power may not always see eye to eye with those at the helm at the Centre. What the finance minister has offered has many flaws, but there is no denying that a basic structure of GST is now in place and a consensus around that has been built with most states agreeing to the idea. With the government deciding to introduce the Constitution amendment Bill to facilitate the launch of the GST regime in the monsoon session of Parliament, the target of April 2011 now looks achievable. While the proposed Finance Ministers’ Council for GST should work towards removing the many flaws the new system will undoubtedly suffer from during the transition period of three years, it should not overlook the one big advantage the new taxation structure should benefit from. The GST rates over the three years are to decline from a high of 20 per cent to 16 per cent. This should make the GST regime politically palatable as tax rates under the new system will be declining.
