Taking forward the grand GST project

It will soon be a year since the government introduced sweeping reforms in the system of indirect taxes by bringing in the goods and services tax (GST). This newspaper has been a strong votary of the new tax, for both economic as well as political reasons. However, Mint has been critical of the complex tax structure that was finally accepted. We had warned in these columns in October 2016 that India was moving towards a messy GST that would restrict its economic benefits. Another editorial in June 2017, written after the GST council had finalized tax rates, pointed out that political optics had overpowered economic logic.

There can be no doubt that India has one of the most onerous GST systems in the world. The World Bank has provided some useful international comparisons in its report on the Indian economy published in March. India has four non-zero GST rates (5%, 12%, 18% and 26%). There are only four other countries with such a complicated structure—Italy, Luxembourg, Pakistan and Ghana. None of them is a paragon of economic virtue. On the other hand, 49 of the 115 countries in a sample used by accounting firm Ernst and Young have a single GST rate. Another 28 use two rates. Also, the top GST rate in India is the second-highest in the world.

In an interview published in the new edition of the International Monetary Fund’s Finance And Development quarterly, released a few days ago, chief economic adviser Arvind Subramanian said the GST council is “acutely aware” of the fact that the complexity of the tax structure has reduced the potential economic benefits. The GST council has over the past year tried to rationalize the initial structure, though a little too tentatively.

Mint believes that India should first move to a three-rate structure, with one rate for a very small number of essentials, one for a very small number of luxuries and a modal rate that will cover most of the economic activity in India. That modal rate should be 12%, and a move to lower GST rates will be possible once there is more clarity on monthly tax collections as well as wider coverage.

In the latter context, Subramanian has also said that another flaw in the current GST system should be addressed soon: “I’m very hopeful that certainly electricity, real estate, and petroleum will at some stage be brought in. But the way I think it is going to work—and the finance minister has said this very clearly—we’re still waiting for the whole GST to stabilize. We’re not quite sure how buoyant the revenue take will be, but once it is, all those sectors can be brought in.” There are already welcome demands from some corners of the political world that petroleum should be brought under GST so as to reduce the impact of high prices on consumers.

The new tax will take time to stabilize. A smooth transition was always unlikely. There continue to be problems such as the delayed input credits to exporters, an especially acute problem at a time when the trade deficit is widening because of higher global oil prices. The monthly tax collections are also not giving a clear sense of what to expect in terms of revenue. The nuts-and-bolts issues will eventually be sorted out, and there are already signs that the shocks to supply chains during the transition are now dissipating.

The more profound problem is the design of the tax structure. It is far too complicated. At least part of the reason is the incentive design embedded in the grand federal bargain on GST. First, states had a low incentive to push for a GST that would increase economic growth because New Delhi has in effect underwritten their budgets with a promise to compensate them if state tax collections grow at less than 14% a year. Second, the policy that all decisions in the GST council should be based on consensus in effect meant that individual states could play spoilers despite being in a minority, or that holdout strategies became potent.

What now? Malaysian Prime Minister Mahathir Mohamad has announced recently that he will roll back GST in his country by reintroducing the old sales tax. India should definitely not go down that path. Even our flawed GST is better than the old indirect tax system. GST will increase productivity by unifying the Indian market. It will help formalize economic activity in India. The GST council is an institutional innovation that will act as a check on centripetal politics.

How can the complexity of the GST be reduced? Tell us at views@livemint.com