To implement GST, much groundwork remains, including the immediate task of passing the Constitutional Amendment Bill in at least 50% of state legislatures, and also to have separate Bills passed in Parliament and states to operationalise GST. More important is the need to forge a nationwide consensus and arrive at a standard GST rate.
Last year, the Arvind Subramanian expert committee did suggest 17-18% as standard GST rate. Going by global experience and as per Kautilya’s Arthashastra, the treatise of ancient India, the most common GST rate should be about 16%.
State governments reportedly want a higher standard rate stipulated, and the GST Council, with the Union and state finance ministers as members, would need to arrive at a solution. To do so, it may require proactive policy to address the issue of high public debt in quite a few states, including West Bengal, Kerala and Punjab.
The point is that a relatively high standard rate cannot be a solution to tide over high public indebtedness in individual states. A suitably attractive rate like 16% should smartly boost tax buoyancy. The GST Council may want to commission additional studies, pore over the latest available data and figures, and even use tools from the domain of experimental economics to arrive at a suitable median rate.
The idea of GST can be traced to a 1971paper on optimal taxation by Nobel laureates Peter Diamond and James Mirrlees. They showed that optimal taxes ought to be zero on all intermediate goods. The underlying concept is to avoid taxes on intermediate inputs to production as these distort and bias the allocation of factor inputs.
There are exceptions to this rule. For example, for goods that generate negative externalities, corrective taxes can be justified. But in most other instances, optimal efficiency calls for tax set-offs right along the production value chain, with the indirect taxes only payable on the value added at each stage of output, with the final incidence of taxation on consumption.
By the mid-1970s, over a dozen high-income economies had valueadded tax (VAT) regimes, although acomprehensive GST was some years away. India moved, hesitatingly, to VAT in a small although notable way in 1986, with Modified VAT (Modvat) on production at the Centre. The plan was to do away with tax-on-tax and cascading input taxes so that tax is only levied on the value-added and set-offs available for taxes already paid.
Modvat has since been labelled Central VAT (Cenvat) and the tax base widened. In 2005, the states switched to VAT on consumption. So, we now have a dual VAT system at the Centre and the states. But there is much scope to further reform the indirect tax regime and make available tax set-offs right across the output and delivery value chain, both at the Centre and the states.
Hence the need for the constitutional amendment on GST so that the Centre can levy tax on the distributive trade, and the states can tax services. Also, GST would subsume a host of additional taxes, such as additional excise duty at the Centre, octroi and entry tax in the states, and would lead to more efficient tax design across the board.
In the next few months, the GST Council needs to keep GST-exempted goods and services down to the very minimum. We need to modernise and widen the indirect tax base so that the rates on such taxes, which are by definition regressive, with the same tax rate payable never mind income levels, remain relatively modest.
The mavens aver that the average GST rate in the advanced economies is about 16.8%. Note also that the Arthashastra mentions several tax rates but the median rate works out to 16.33%. It would make eminent sense for the GST Council to choose 16% as the standard rate.
The revenue-neutral rate, which would protect existing central and state taxes, as per the Subramanian panel, was about 15.5%. Petroleum products need to be included in the GST regime in a time-bound manner, although with additional taxes to justify externalities. Ditto for ‘sin’ goods like potable alcohol.
GST rates for different items can range from a low of, say, 4% on gold to 12% for essential items to a peak rate for items consumed by the affluent. A single GST rate can wait.