Isn't 20% too high a rate for revenue-neutral GST?

The introduction of VAT has indeed been a paradigm shift in the Indian tax system and the most remarkable fiscal reform at the sub-national level since Independence. As a next step, goods and services tax (GST) will be in the statute book from April 2010 to pave the way for a common Indian market. However, in the introduction of GST there still remains some ambiguity concerning the proposed rate(s) of tax for the GST.

As per the available information, the structure of the proposed GST will not be like the goods and services tax as prevalent in other VAT countries nor will it be on the pattern of the Indian Goods and Services Tax, as suggested by the Kelkar Committee.

The proposed GST, as recommended by the Report of the Joint Working Group (JWG) on Goods and Services Tax and further modified by the Empowered Committee (EC), will have different rates and base of tax for goods and services under CenVAT and under the state-VAT. Therefore, the GST will not have a dual VAT structure but a quadruple tax structure.

It will have four components, viz. (i) A central tax on goods extending up to the retail level; (ii) A central service tax; (iii) A state-VAT on goods, and (iv) A state-VAT on services. Given the four fold structure, there will be at least four rate categories- one for each of the components given above. In this system the taxpayer will be required to calculate tax liability separately for the different rates of tax.

It will also require dealing with different tax authorities for different components of the tax. Such a tax system will be very difficult to administer. It is, therefore, necessary that the JWG and the EC do some rethinking on the rate structure of the proposed GST.

Given the present rate of 16% on goods (with some rates lower and some more than the 16% rate) and 12% on services under CenVAT and 12.5% (with some other rate categories of 4% etc) under State-VAT, the revenue neutral rate would work out to be around 20% — with Centre levying 12% and the States levying 8%. The Kelkar Task Force has also recommended such a rate for GST.

It is, however, felt that a high rate of GST of this level at the retail level will pose problems in administration of the tax. With the noted exception of Scandinavian countries, where the standard rate is 25%, only few countries have been successful in levying a high rate of GST. Successful models of GST suggest a rate of tax in the region of 10% or less.

The proposed rate of GST should preferably be in the vicinity of 15% of which a 7% rate to be levied by the CenGST and 8% by the State-GST. This could be accomplished by readjusting the bases of both the components of GST, given the fact that approximately 40% of the revenue of CenVAT and state-VAT (accruing from petroleum products), is not under VAT.

The proposed low rate of GST should be levied on all goods and services with a few exceptions. As of now, the notable exemptions under the CenGST include those granted to small scale industries, and units under the backward area schemes.
The exemptions from service tax should also be unified and the tax be made a general tax rather than a selective tax.
On the same lines, under state-VAT also all exempted goods need to be brought under the tax net.

In doing so, there is a politico-economic argument to leave out essential commodities like food, medicines, clothing etc. from the tax base. However, empirical exercises indicate that the benefit of an exemption to a necessity is proportional to amount spent on tax-exempted items. Hence, such exemptions benefit upper income families more because of their larger spending power.

Hence, all these items must be brought under tax net and the government should provide direct subsidy to the poor consumers.

The next step involves making the bases of Central GST and the State-GST similar. This would entail giving all the services to the states, except for a few services to be placed under the negative list. There should be sumptuary excises imposed on a few (not more than a dozen) select commodities.

This will ensure the additional mobilisation required to have a revenue neutral rate for the Central GST.

To conclude, a low rate will ensure an effective GST. The JWG and the EC should consider having rates of GST in the vicinity of 15% —7% imposed by the Centre and 8% by the states. It should be the same for all goods and services, with as broad a base as possible.

The Centre will get additional revenue from sumptuary excises and the states a buoyant revenue from the tax on services.

Source : Economic Times - Gurgaon, Haryana, India,  dated 26/02/2008