Complex tax systems are regressive in their compliance burden. It's time to make the GST a good and simple tax that is both efficient and just
The last column in this space argued that in a world full of complex choices, simple rules are better than complex ones. It made a case to simplify the good and services tax (GST) to a single rate to rid Indians of a complicated classification system. One can extend the logic of this argument to simplifying the GST compliance process as well.
Often, the argument used against simplicity in the GST system is the lack of uniformity in the real world. The economy comprises different individuals and firms which come together in a beautiful dance coordinated by the price system. When the individuals and firms are so different, is it fair to treat them equally? After all, the entrepreneur owning a small sweet shop is not in the same position as the entrepreneur owning a luxury car showroom, and fairness demands that the rich pay higher taxes. To make the system just, barfis are taxed at 5%, luxury cars at 28%.
Unfortunately, the noble intention of helping smaller and poorer firms by using multiple tax rates often results in making them worse off. Though 5% is a lower tax burden than 28%, the complicated GST system, with its five different tax rates and myriad exceptions, poses a disproportionately high compliance cost on the sweet shop. The burden to comply with the GST is very similar for both small and large firms. And because the compliance requirements and therefore the costs are similar, a small firm pays a much larger proportion of its earnings to deal with compliance, relative to a large firm. In this sense, a complicated tax system is regressive, because it forces the poor to spend a greater proportion of their earnings on the compliance burden imposed by the tax. Creating complex systems to maintain a progressive tax can perversely create a regressive tax structure once compliance costs are considered.
It is the small firms, shops, and individual innovators and entrepreneurs who need simple rules the most. They need to use the scarce resources at their disposal to best serve their customers, instead of using those resources to pay professionals to help them understand complicated regulatory and tax requirements. The sweet shop owner potentially benefits more from simplicity than a luxury car business.
The GST compliance system has three parts to it. First, each taxpayer needs to figure out the classification and the rates applicable to their good or service. Second, each taxpayer must understand the classification and the rates applicable to their inputs. And then finally, the taxpayer must file returns and pay taxes. Each of these tasks is so complicated and costly under the present regime that small firms and individual proprietors need to devote a significant proportion of their resources to understand and comply with the GST regime.
The classification system is quite clearly a mess, as discussed in the last column in this space. Each taxpayer must navigate the 438-page long HSN (harmonized system of nomenclature) code book with its 18,306 entries to identify which of the five tax rates apply to the good or service. Any additional cess, sometimes levied by individual states, must also be added. This is no small task. There are disputes and notifications, to be tracked almost on a daily basis, to even calculate the criterion for the tax burden.
However, the compliance nightmare does not end there. One of the main advantages of the GST system is that it provides an incentive for all members in the supply chain to ensure that taxes have been paid at each level. In cases where the supplier has not paid the tax or is exempt, the receiver pays the tax. However, the more complicated the tax classification and rate system, the harder it is to understand the tax burden of all the inputs. For instance, a Diwali gift basket requires different sweets and dry fruits as its inputs. If the barfi seller is unclear on whether he must classify a chocolate barfi as a chocolate at 28% or as a barfi at 5%, then the seller creating the gift baskets is also affected. Perhaps the barfi seller does not pay the tax, in which case it falls upon the gift basket sellers to figure out whether to pay 5% or 28% on the barfis and collect it from the barfi seller. Alternatively, the barfi seller pays the incorrect amount, affecting the tax payments and deductions of the gift basket seller. So the more inputs required for any good or service, the higher the compliance burden created by multiple GST rates. It is not enough to have clarity on one’s own tax classification; this extends to every single input. This can get extraordinarily messy and costly.
Much has been said about the extremely cumbersome filing system, where taxpayers had to file monthly returns for Central and state GST. While a move has been made to reduce the frequency of filing returns, the process will be easier and more streamlined with a single rate. If there is no confusion over the tax rate, more businesses are likely to file and submit vouchers on the goods and services tax network on time, which means it is easier for sellers to match vouchers for their inputs and meet their tax and filing requirement with ease and on time.
All this can only be resolved by having a single GST tax rate. If there is no confusion over the tax rate for different inputs, it will help the incentive mechanism built into the GST system to work more smoothly. Complex tax systems are regressive in their compliance burden. It’s time to make the GST a good and simple tax that is both efficient and just.
Shruti Rajagopalan is an assistant professor of economics at Purchase College, State University of New York, and a fellow at the Classical Liberal Institute, New York University School of Law.