A messy GST, and the road ahead
The current structure of the goods and services tax (GST) is seriously flawed, the result of messy political bargaining
Here is a delicious titbit for all connoisseurs of complicated tax rules. The government has clarified this week that food takeaways from air-conditioned restaurants will be taxed at 18% even when the customer is handed over the food in an area that does not have air-conditioning. Who is going to impose this rule? What if a restaurant owner registers the takeaway business as a separate entity? The mind boggles.
This newspaper has been a strong votary of the goods and services tax (GST)—and especially the clean structure that was originally envisaged. That is why we have also repeatedly argued in these columns that the complicated GST structure that has been rolled out is an imperfect version of the new tax.
Some of the decisions taken by the GST Council earlier this month highlight the problem in a stark manner. A lot of media attention has been focused on the steep increase in the cess that has to be paid on luxury cars. There has been a lot of other tinkering as well.
Admission to planetariums will now attract a lower tax. The margins payable to fair price shop dealers will be tax-free. So will goods that are to be imported for the Under-17 football World Cup this year. The burden of GST in the case of plumbers or carpenters selling their services online will now be borne by e-commerce companies. Rental cab services will have the option of paying a higher GST rate with input tax credit or a lower rate without input tax credit.
And this needs to be quoted in full, if only because it brings back dark memories of budget decisions taken in the 1970s or 1980s: “Job work services in respect of the textiles and textile products (including MMF yarn, garments, made-ups, etc., falling in Chapters 50 to 63)” will attract a lower GST rate.
This is the sort of tinkering that eventually led to a complicated tax structure before the 1991 reforms—a tax structure that distorted production, encouraged lobbying and gave huge discretionary powers to the taxman.
The problem is even deeper once the main economic argument for GST is understood. It is supposed to be a national value-added tax that targets final consumption rather than the production of intermediate goods. This design satisfies the rules by modern theories of optimal taxation, for example in the work of economists such as Peter Diamond and James Mirrlees, who both went on to win Nobel prizes.
The GST in its current form has five rates. It is very likely this has led to cases of inverted taxation. The tax on inputs is higher than the tax on output. There is even an outside chance—think about it—that such inverted taxation could lead to the rather absurd situation where the government will have to pay companies to produce. The principle of a destination-based tax is blown away when there are embedded input taxes.
The imperfect GST that India now has is still superior to the inefficient indirect tax system that it has replaced. But two things need to be done now.
The first is that the complexity of the GST structure right now, as well as its novelty, will mean that companies will take time to figure out their tax liabilities. There will be honest mistakes. The government would do well to give taxpayers the benefit of doubt in the first few months. There should be regulatory forbearance to avoid the prospect of overenthusiastic tax officials assuming that every mistake is a crime. The Union finance minister, in turn, must reassure tax officials that missing tax collection targets will not be held against them.
The longer-term issue is streamlining the GST structure. Purists may demand a single-rate GST, but a more viable option is to move to a three-rate structure—0% on items of mass consumption, 12% on most goods and services, and 28% on sin goods such as cigarettes.
The cesses have been imposed temporarily to compensate states for potential revenue losses. They should be the first to go once tax collections pick up. The next step should be to move as many goods and services as possible to the median GST rate of 12%.
This admittedly cannot be done overnight. It will need to be a process over the next three years or so. But for that process to have a chance, it is essential that more people accept that the current structure is seriously flawed, the result of messy political bargaining.
How do you think the current flaws in the GST rate structure can be fixed over time? Tell us at email@example.com
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