India’s GST Must Eventually Evolve to Just One or Two Slabs

While the council’s logic for multiple slabs may run counter to the philosophy of a good GST, it was necessary to get the project off the ground. Its future structure should absolutely avoid the temptation of arbitrary rate fixation.

Note: This article was first published on May 31, 2017 and is being republished today in light of the nation-wide roll-out of GST. Many of the issues raised in this piece are still worth considering as the country goes through teething issues.

After much deliberation and compromise, the Goods and Services Tax (GST) rates were announced at the GST Council meeting in Srinagar in May. The multiplicity of tax rates appears daunting, but the very fact that the GST is now almost ready to be rolled out more than ten years after it was originally announced is worth applauding.

GST is slated as the biggest tax reform in the nation’s independent history and is expected to contribute significantly to the growth rate. The increase would emanate from uniformity in tax rates for the same item across the country. State governments through the empowered committee of state finance ministers consented to give up their taxation powers in the interest of the larger good. Indeed, the GST negotiation over the years represents a protracted and painstaking process of consensus-building, and its success in itself demonstrates that consultations can be effective.

The rate slabs for goods were decided in November 2016, to distribute all products in tax rates of nil, 5%, 12%, 18% and 28%.

A cess added further complexity to the five slabs. The council’s logic for multiple slabs may run counter to the philosophy of a good GST with a single common rate for almost all goods and services, but ahead of a council meeting to decide the slabs, finance minister Arun Jaitley presented a strong case:

Some have suggested that a multiple tax rate is disadvantageous to the GST and would neutralise some of the advantages of a uniform tax structure. The reality is that a multiple tax rate in India is inevitable for several reasons.

Different items used by different segments of society have to be taxed differently. Otherwise, the GST would be regressive. Air conditioners and hawai chappals cannot be taxed at the same rate.

In a country that suffers from income inequality – the richest 1% of the population enjoys over 50% of the wealth of the nation, while the poorer half of the population can lay claim to just over 4% – some rules must be in place to avoid an added burden on the poor.

Another reason given by the FM was the need to protect the revenues of the government, keeping the tax incidence under the new regime revenue-neutral. This would not have been possible in a single-rate structure where the rate would necessarily have had to be kept high to avoid a loss to the government. Any substantial fall in revenues would impact the government’s spending programmes including for building infrastructure and protecting vulnerable sections of society.

A third rationale for multiple tax rates is the impact of GST on inflation. Placing a higher tax rate on some goods that have a high weight in the consumer price index may have added to the price rise, which in itself would have a significant negative impact on demand, investment and growth.

The fitment of rates as finally decided by the GST Council in its Srinagar meeting, keeps a large number of items of interest to poorer consumers out of the tax net, while taking care to ensure that the inflation rate is not adversely impacted.

The complexity in the goods part of the GST rate structure arises from definitions of various sub-categories. Most of the chapters in the harmonised system (HS) are subject to dual rates, while for many items such as milk and milk products, there are as many as four rates. The rate schedule clearly delineates the items at the four-digit and at the eight-digit level where required, so this should not pose a problem for manufacturers who would be aware of the HS codes of their products. However, in some areas, definitions require clarifications.

While the structure of taxation for goods was expected, the extension of the four-tier model for services comes as a surprise. Most services are placed under the 18% bracket, but transport, restaurants and hotels have been treated variously, depending on the pricing structure. As pointed out by the hotel industry, for example, hotel rates are flexible and seasonal and would depend on inflation, wage structures, availability and so on. Arbitrary divisions of Rs 1000, Rs 2500, etc. may be clearly linked to key parameters.

Certain items have not yet been addressed in the GST structure and are expected to be taken up at the June 3 meeting. These include important categories such as textiles, footwear, gems and jewellery and agricultural machinery.

One must keep in mind that GST replaces multiple taxes levied under the current system. Apart from a plethora of rates for central excise, cesses, countervailing and special additional duties, each item is currently subject to different taxation rates in each state, multiplying the complexities. This has hampered the interstate movement of goods, including through taxes imposed on the entry of goods at state borders. Given that producers have been able to deal with such a convoluted system, GST should turn out to be an easier proposition.

A key advantage of GST is that the entire system is online. The benefits arising from each transaction being tracked through the supply chain across the country can be considerable. The tax net will be more difficult to elude, and with the input tax credit being available only if all players pay tax on time, tax avoidance can be curtailed. The GST process envisages three monthly filings and one annual filing of taxes, all to be completed online.

As a beginning, the GST is mostly welcome in terms of rate structures. A few issues must be kept in mind to make the GST more efficient in later days which would include bringing in petroleum, real estate and others which have been left out of GST purview into its fold. Eliminating cess imposed for compensation to states would also figure on the to-do list a few years hence.

Going forward, a simple GST structure would imply convergence of rates to just one or two slabs, adding clarity, stability and certainty to indirect taxes. While it is premature to speculate on the future shape that the rate structure may take, it should be possible to combine the exempt and 5% categories into a single slab within that range.

Similarly, the 12% and 18% rates can be collapsed into a single standard rate applicable to most articles, which would not place much incremental burden on taxpayers. The higher rate of 28% for more expensive discretionary consumption items could also be converged with the standard rate some years down the road. As disposable incomes of Indian households rise, goods which currently appear to be luxuries (chocolates, certain paints, sanitary ware) may well become items of mass consumption. That said, however, there will remain some goods where high tax rates may be necessary, not to raise revenues, but to discourage consumption.

A central consideration for the future tax structure is that GST must avoid the temptation of arbitrary rate fixation, as was possible with the excise regime where central government budgets could announce changes in rates on items as specific as pasta. Shifting of items from one rate to the other merely leads to discretionary powers in the hands of tax authorities, and discourages investments which are based on the certainty of policies.

There is bound to be some confusion on GST rates as the tax is rolled out in July, especially since several other issues such as e-way bills, anti-profiteering clause and others are yet to be resolved. For a mammoth exercise of recasting the way India pays taxes, patience is the order of the day and hopefully, concerns of industry in GST implementation and complexities will be ironed out in days to come.

Sharmila Kantha is the principal consultant at the Confederation of Indian Industry. Views expressed in this article are personal.