In a pleasant surprise, the panel on GST, headed by Chief Economic Advisor Arvind Subramanian, has, among other suggestions, proposed a revenue neutral rate (RNR) of 15 per cent and a standard rate of 17-18 per cent for the proposed nationwide indirect tax. Bloomberg TV India caught up with Subramanian on the crucial tax reform and what it means for India's growth momentum.

How did you arrive at the rates when some earlier estimates put it as high as 27 per cent?

The question is a fair and valid one. I think this committee had the benefit of not just one way of looking at the RNR calculation but many ways — in fact we had three different ways of looking at it. So we were both able to see what were the shortcomings and what were the benefits of the other approaches. We made a very technical evaluation of all of this and came up with this number.

Then we validated it against other benchmarks. For example, if the RNR is X, how is it compared with other countries? It was a kind of two-to-three-stage process — first listening not just to one but two different approaches; second, critically evaluating them and coming up with our own number; and third, validating it against that. That’s what has led to a different number to what most people have been used to.

How acceptable do you think this would be to the States, because they are the ultimate stakeholders in this process?

Well, the matter of acceptability really depends on what are the objectives and whether this rate actually does preserve revenue or not, which I think they are very interested in. So if the numbers are remotely right, I think broadly all stakeholders should be happy about adopting something close to what we are recommending.

What is the central philosophy when it comes to the design?

I think the simple way to explain this is that, the way to design a good tax is — make the base as broad as possible and make the exemptions as few as possible. And, if you can do that, you can actually bring down the rate. That’s the simple philosophy. That is where we are headed. Even in the Empowered Committee (of State Finance Ministers), they have decided for example that the list of 300 exemptions should come down to 90 at the Centre. So, we are in any case moving in that direction. What the report did was just calculate assuming you get a broad base and come up with a number. It also recommended that going forward this process should continue because there are still exemptions or exclusions from the GST and the more we can fill those going forward, even better the tax can be, better than it is currently designed.

Currently, many of the important items including real estate, alcohol, petroleum and electricity are left outside the GST structure. How much do you think your suggestions can be acceptable with the Empowered Committee, given that you are talking about the inclusion of pretty much everything including alcohol in the tax?

The omissions from the GST are political decisions and calculations. From an economic desirability point of view, the lesser the exemptions, the better it is. That is something the political process has to work on over time. We are not saying, unless you do A, B or C, it is not worth it. We are pretty much working with what has been currently broadly agreed upon, tweaking it in a few ways and saying that, this kind of overall thing should be implemented as quickly as possible.

Where does your report figure as an input in the current process — because the draft law is already being prepared by the Finance Ministry?

This is a kind of tactical input that others hopefully will take into account when they actually design the policy. This is what I expect will happen. How exactly it is taken into account, which bits are accepted, which are not, those are political calls that will be made. But I think what the report does, maybe it is fair to say, is that it kind of sets the context to what would be desirable going forward. We are advisors, not deciders. So we can only provide technical inputs and so on.

Can this then be considered a sort of summary of the thinking of the advisors in the Finance Ministry?

It was a committee — it had people from the revenue department, people from the CBEC, people from the State governments and we drew on a lot of outside help as well. So it is a technical effort drawing upon national and international technical wisdoms. In that sense it is a very broad-based input.

On the course correction that you advocate, the 1 per cent additional levy, is there a broad consensus within the Finance Ministry?

This is a committee recommendation. So I would not want to speak on behalf of others. It is a technical recommendation founded in economic logic and I think that economic logic is broadly accepted by everyone.

What about the logic that the States which were comfortable with that levy will be compensated…or do they have alternatives?

We did some preliminary analysis trying to see how valid and realistic these anxieties are. Our broad conclusion is that there will not be too much shifting of the tax base. What we find, for example, is the large States which get a lot of revenues now mostly from manufacturing are also going to be the large consuming States of services. So in that sense they don’t need to get anxious that they are going to suffer a huge loss in revenue.

Our assessment broadly is that there shouldn’t be too much of a reshuffling of tax base, which will require a lot of compensation. To the extent that they will need to be, I think it will be fairly small and the government has committed to doing that. So in that sense we should be able to reassure those who are anxious, both that we don’t think there is going to be much loss and, even if there is loss, the Centre is standing behind you for five years.

What about the anxiety of the taxpayer?

By definition, if the new rate has to be revenue neutral, there should be, on an average, no price impact — that is the definition of revenue neutrality. However, we know that because the nature of the tax is changing a little bit even though overall it is neutral, there can be shifts and distribution also. We have to be mindful of what happens to the poorer section. We have devoted a lot of time in this report to analyse the impact on inflation and what we find is that broadly there is very minimal impact. So from that point of view I think the consumers should be reassured. Given the experience in other countries some things can happen — some odd commodities.

So we suggest price monitoring that takes place in the Centre and States to make sure the disruptions are avoided. What about taxpayers? Given the simplification, the rationalisation, the fact that rates are going to be what they are, the common base, all these will facilitate taxpayer compliance and that is why we expect efficiency gain in term of tax collection. So, with a given level of rates and not by raising it, you can increase your revenues. It is also good for taxpayer compliance.

Could a better compliance lead to a 12 per cent RNR?

If it happens over time, it will be wonderful.

Have you said anything about the manner in which revenue sharing happens among States and the Centre?

Broadly, it has to be revenue neutral at the level of both Centre and state.

The structure of the rate should ensure that whatever the two sides are getting today will be the same tomorrow.

Today, States are getting more revenues than the Centre, so the future rate structure should reflect that as well.

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