Why a cap on GST Bill makes economic sense

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The country is on the verge of passing a landmark reform in taxation. The Goods and Services Tax (GST) will radically alter the way indirect taxes are collected and administered. The basis of taxation will move from production to point of final consumption. Currently, there are two kinds of indirect taxes, one of which are collected by the Centre, and the other by the States. The Centre also collects import duty on goods produced in foreign countries, which will remain outside the ambit of GST. Excise tax is a production tax, levied on goods as soon as they leave the factory gate. Service tax (around 15% now, including the Swachh Bharat cess) is levied on services. Both these are collected by the Centre. The States charge sales tax (also called Value Added Tax, VAT) on goods sold within the State boundary. Inter-State sales attract an additional Central Sales Tax, payable to the Centre. All of these taxes will be replaced by a single GST, administered at the point of consumption. Some other taxes like octroi, local body taxes and others will also get subsumed.

The GST paradigm is a fundamental shift, because it calls for all States to surrender their right to collect sales tax, and for the Centre to surrender its right to collect excise and service tax. In exchange, the GST collection will be split between Centre and States. This grand bargain achieved after a long period of painstaking discussions and debate requires a constitutional amendment. Hence it needs a two-thirds majority in both houses of Parliament to pass.

The GST bill was passed by the Lok Sabha last year, since the BJP and allies have a comfortable majority. It is now stuck in the Rajya Sabha, where it needs 164 out of 245 votes to pass. The Congress party with 60 votes has assured its support if three conditions are met. The first two conditions relate to a dispute resolution mechanism within the GST Council and about eliminating an extra one percent levy on top of the GST. Both these conditions, or an appropriate modification of those, are likely to be agreed by the BJP. But the third condition is the sticky point. The Congress has asked that an upper ceiling of 18 percent on the GST rate be introduced in the amendment. The BJP is unlikely to agree. It is possible that some compromise on this too might be worked out.

Without going into the politics of the GST bill negotiations, it is worth pausing and asking whether a cap on GST makes economic sense. Taxes are of two kinds: direct and indirect. The former includes income, wealth and capital gains tax. Higher your income, higher is your tax burden. That’s not the case with indirect taxes.

Anyone who buys soap, or toothpaste or biscuits, pays the same sales tax, whether he is rich or poor. Naturally, the poor bear a disproportionally higher burden. Indirect taxes are inherently regressive. Hence, we should minimise the taxes collected through regressive indirect taxes, and widen the tax net for income and wealth tax. But in India, 65 per cent of our tax collections come from indirect taxes. Only three per cent of the population pays income tax. India’s ratio of direct taxes to GDP is one of the lowest in the world. No wonder, Prime Minister Narendra Modi urged tax officials recently to go and double the number of Indians who pay income tax.  Unfortunately, India’s record on this count is dismal.

Indirect tax rates keep going up (service tax rate used to be 5% and now is 15%), while direct tax rates keep going down, with no commensurate widening of the tax net. Governments have always found it easier to fill their coffers by tweaking indirect tax rates to make them go higher. This is done so unobtrusively that maybe it’s not even noticed. For instance, the excise on petrol and diesel was raised a dozen times in the last one year, and all that is indirect taxation.

When the GST system is in place, it would be ‘oh so simple’ to simply raise the rate from say 18 to 19 per cent, and gain immensely in tax collection. The tax buoyancy is very high. But achieving similar increase via direct taxes would need much bigger effort and political will. Ultimately, the silently increased and highly widespread indirect tax hurts the poor much more than the rich. It will worsen income inequality in India from levels that are already dangerously high.

It is for this reason that it would be sensible to hardwire an upper limit of the GST rate in the legislation itself (not necessarily in the constitution). There is a precedent to this. When the Fiscal Responsibility law was passed, an upper limit of three per cent of GDP was specified in the law. That put a constraint on the fiscal freedom to spend, but for a good cause.

The GST rollout will make India a common unified economic market. It is expected to increase GDP growth by one per cent every year. It will remove inefficiency induced by the current disintegrated tax system. It will also increase tax compliance due to in-built interlocking incentives. No more selling goods or services “without a receipt”.  But all these gains require that a cap be kept on the GST rate to prevent a drift to regressivity. We should urge lawmakers to quickly forge such a consensus and let GST finally see the light of day.

Source: http://www.freepressjournal.in/analysis/why-a-cap-on-gst-bill-makes-economic-sense-ajit-ranade/896044

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