Home / Opinion / Tasks before the GST Council

Two big reforms happened in August—final passage through the Rajya Sabha of the Constitution Amendment Bill to enable the goods and services tax (GST), and the big-bang reform of bank engagement with the corporate debt market at the end of the month. Of these, the first demands more attention because it still has to be rolled out through the GST council. The second is a package, some of which gets into play immediately; some others will require amendment of the Reserve Bank of India Act, but face no other procedural obstacles.

Of the tasks before the GST council, the most potentially troublesome mandates revenue compensation for states for five years. This was among the changes negotiated for successful passage through the Rajya Sabha of the amendment bill. The previous version merely permitted compensation for a period of up to five years. The new mandate will make legislative attention swirl around the compensation formula arrived at by the GST council.

Under normal conditions, the absolute indirect tax revenue collected by states increases over time. For example, the indirect tax revenue of all states in aggregate has in recent years been increasing by roughly 1 trillion every year. Within the absolute aggregate, every state likewise sees an increase in absolute revenue from one year to the next.

The issue is whether with the introduction of GST, this historical experience is set to change (in the initial post-GST years). Absolute revenue will continue to increase in aggregate but perhaps by less initially than in the pre-GST years, and of course differentially from state to state. The issue is whether individual states should have their prior rates of percent revenue growth protected (as happened when the state value-added tax, or VAT, was introduced in 2005). That formula had the virtue of simplicity, but it was needed for a shorter life of three years with declining percentage compensation, and most of all, there was no constitutional mandate driving it. Configuring a revenue compensation formula in the new circumstances facing the GST council will involve determining what the revenue would have been had the pre-GST structure been in place—what economists call the counterfactual. But that is very difficult to do, especially when states slated to lose revenue from elimination of the central sales tax, or CST, could actually see a revenue increase from the dynamic impact of the reform. The GST council has to settle the compensation formula before the GST roll-out, so as not to let it get impacted politically by the inter-state pattern of incremental revenue experiences.

The standard rate at which GST is levied, the biggest task before the council, will be an important determinant of the revenue compensation payable in aggregate by the centre to states. This has had the benefit of the truly excellent prior work done by the finance ministry committee chaired by chief economic adviser Arvind Subramanian. The committee has done invaluable work on mapping from a single revenue-neutral rate onto what will necessarily have to be a multiple-rate structure, with a standard rate surrounded by one or more satellite rates.

The GST, like the VAT on goods which it replaces, is a tax on consumption. What matters for the final consumer is the GST rate applicable on business to consumer (B2C) transactions of a particular good or service. Since all input taxes (B2B) are rebated, whatever they may be, the producer gets no benefit at all from a concessional input tax—if he pays less, he also gets to rebate less. The consumer gets no benefit from a concessional input tax either since the B2C tax on the good purchased incorporates only the cost of the input, not the tax on the input.

This point is relevant because of the swirling discussion on whether the GST, at a presumed standard rate of 18%, will cause a rise in inflation since services are presently taxed at 15% (inclusive of cesses, which incidentally will have to melt away with GST). As said above, the rise in the tax rate on B2B services will have no upward impact on the prices of goods into which they go as inputs. On the contrary, since central excise and service tax will now become rebatable, the pre-tax price of the good will actually go down. Yes, there will be a rise in the tax payable on B2C services, such as restaurant meals and haircuts, but on the service component of the final bill alone.

But if a particular B2C product is exempted from taxation altogether, such as unprocessed foods like rice and wheat, an input tax rebate on fertilizer cannot be claimed, since no tax is payable on the final agricultural crop against which the rebate can be claimed. In that case, the rate of input taxation matters since it does get worked into the cost of the final output. If agricultural crops are exempted, a concessional tax on fertilizer will indeed hold down the cost of food.

Instead of an exemption, if unprocessed foods are included within the ambit of GST but at a zero rate, then fertilizers, which are exclusively B2B, can be taxed at the standard rate, and rebated against the final good. And under such a zero-rated structure, agricultural produce will actually cost less than if it is just exempted. Zero rating within the GST rubric is better than exemption in terms of impact on food prices and, therefore, on equity grounds as well.

The problem is that zero-rating for agricultural crops is a non-starter. It will be difficult to draw into the tax network the multitudes of small farmers to process their rebate applications. So, that is where the justification for exempting agricultural output rather than zero-rating comes in, along with the case for concessional taxation of fertilizer. With fertilizer, other agricultural inputs will come crowding in claiming concessional tax rates as well, such as pesticides and tractors. In these and all other cases, retention within the GST network with a concessional rate is always preferable to exemption.

The existing pre-GST taxation on agricultural inputs consists of a crazy patchwork of exemptability under central excise (which brings in the baggage of unrebated excise and service tax paid on their inputs), CST on inputs bought from outside the state, and the state-level VAT. Industry representations have usefully worked out the aggregate present tax burden on agricultural inputs as lying somewhere in the 14-17% range. A 16% concessional rate on agricultural inputs within the GST structure will, therefore, hold the tax burden at present levels, and enable adoption of a standard rate no higher than 18%.

It is important to remember that concessional input taxation for agriculture will carry corollary problems. Once pesticide as an agricultural input is taxed concessionally, pesticide sold B2C for household use will ask for rate parity on the grounds that tax rates have to go by product, not by usage. This spread has to be contained by the council marking out the principles guiding rate decisions.

The case for taxability exemption thresholds for turnover is the same as what keeps agriculture out of the GST net—the impossibility of including all small retail outlets within the tax net. This will be much easier to work into the system if the threshold is uniform across states.

The entertainment tax stands subsumed into GST, except where it is levied by panchayats, municipalities, regional or district councils. Since nothing in the amendment specifically prohibits levying the GST on entry tickets to tourist sites, I hope the GST council will consider extending the net to include that. The total revenue from ticket sales at tourist sites under the Archaeological Survey of India, recorded under non-tax budget head 0202(04)800, amounts to a little over 100 crore. This vastly understates the total value of ticket sales, through a variety of well-known evasion avenues. Electronic collection at a formal GST window would block evasion, and provide a much-needed fiscal boost for the regeneration of heritage sites.

Finally, legislative changes have to be presented to the public in a form they can understand. Amendments to the Constitution or to particular Acts are documented only in terms of alterations, substitutions and deletions in the wording of segments of clauses which are referred to by a number in the law being amended. They are, therefore, not stand-alone documents and can be understood only by holding the original enactment alongside, and constantly referring to it. It should surely be possible to present the amended clauses in their full form, juxtaposed against the clauses being replaced. In the case of GST, the further amendments made for passage through the Rajya Sabha are available only in the form of alterations to the amendment bill as originally passed in the Lok Sabha. Could the GST council now issue the final form of the State and Union Lists in the Seventh Schedule to the Constitution, as they read after the constitutional amendment, and the further Rajya Sabha amendments to the amendment?

Indira Rajaraman is an economist.

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