Getting the GST rates right

Updated on: Nov 01, 2016
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The rates under consideration now can be tweaked to garner more revenue without affecting consumers

Implementation of the Goods and Services Tax is moving ahead apace, and doubts about meeting the April 1 deadline are diminishing. The Government has demonstrated a political will and has created a ‘national focus’ on GST.

The GST Council is presently engaged in deciding the rate structure. This is an important but complex task as the Government seeks to achieve multiple objectives, of being: pro-poor, anti-inflationary, pro-aspirational middle-class, pro-States, and pro-revenue.

The Centre has promised to compensate the States for any shortfall in revenue below the stipulated normative rate of growth of 14 per cent calculated on the revenue base of 2015-16. The revenue growth of 14 per cent represents a compromise that averages the growth rate of both the leaders and the laggards witnessed over the past five years. The Centre’s commitment, therefore, creates a revenue challenge which the rate structure must meet.

Fixing the rate The GST Council is seriously considering a rate structure of 6 per cent, 12 per cent, 18 per cent and 26 per cent, and 26 per cent plus cess levied on some luxury goods or what is termed ‘demerit goods’.

At the last meeting, which was inconclusive, it was decided that the exact compensation requirement would be computed to decide on the rate of cess to be levied on demerit goods, after which the rate structure could be finalised.

There appears to be some consensus that the cess should only be levied on demerit goods, which are currently subject to a rate of 26 per cent or more.

The question that arises is whether what is on the table proposed by the Centre and deliberated by the Council is the best option in the circumstances. It would appear that there are some other options available.

First of all, cess is a bad idea. It would distort the duty structure and prevent the Government from creating a rational rate structure free from compensation compulsions. It would be far better to go for a demerit rate of 40 per cent in which the States would get an equal share of revenue, minimising in turn their compensation requirements. In the present proposal, it appears that there would, in effect, be three standard rates as about 25 per cent of the total revenue would accrue equally from each of the three rates, namely 12, 18 and 26 per cent, respectively.

Even the 18 per cent standard rate suggested in the CEA’s report would translate to an effective rate of 19 per cent as subsuming the cesses was not factored in the CEA report.

Therefore, a better structure of rates could be 5 per cent, 10 per cent, 20 per cent and 40 per cent. Precious metals could carry a special rate of 6 per cent instead of the proposed rate of 4 per cent or, alternatively, the precious metal rate could be raised to 5 per cent and merged with the proposed 5 per cent merit rate.

This would leave four rates, namely, 5, 10, 20, 40 per cent, with 20 per cent being the standard rate accounting for more than 50 per cent of the total revenue. The suggested rate structure would still probably leave a revenue gap to meet compensation requirements.

New revenue option To meet this, the Government could consider a new revenue option of imposing GST on unmanufactured tobacco at rates to be decided by the council. Presently there is no Central levy on unmanufactured tobacco but some States collect VAT on sale of tobacco. GST could be collected from the purchaser of unmanufactured tobacco much like Central Excise duty currently levied and collected from the purchaser of molasses. This levy would leave farmers completely out of the administrative domain of taxation.

Tobacco taxation at source was recently mooted in an article by Vijay Chhibber, formerly secretary in the road development department. He makes the point that out of total tobacco production of 520 million kg, hardly 100 million kg bear local VAT levies.

About 420 million kg of tobacco are largely outside the tax net. This is illustrated by the fact that a tobacco-growing State such as Chhattisgarh hardly collects ₹13 crore as VAT on sale of tobacco.

The numbers would suggest that the Centre could conservatively collect ₹25,000 crore annually which would be shared by the Centre and the States (there would be no SSI exemption). GST duties on unmanufactured tobacco could be adjusted against GST duty payments on various tobacco products, creating an audit trail. Revenue would accrue to the extent the unmanufactured tobacco is used in the exempted stream of manufactured tobacco products. This would also bring down evasion in the tobacco product segment, by incentivising tobacco product manufacturers to report more transactions in order to avail themselves of the duties paid on unmanufactured tobacco in the earlier part of the supply chain.

Because the GST transactions of tobacco, like other GST transactions, would be uploaded on the GSTN portal, these could be tracked. Tax payment not only generates revenues, it creates an information trail for public policy. In this case a vigorous health policy could be built around disincentivising tobacco product consumption, especially chewing tobacco.

So we have now the broad contours of the rate structure: 5 per cent, 10 per cent, 20 per cent, 40 per cent (demerit rate); special rate of 6 per cent which could be merged with the 5 per cent rate; and a new GST levy on unmanufactured tobacco.

Some advantages What are the advantages of this proposed alternative rate structure? The goods in the CPI basket which predominantly drive inflation would face lower duties — the 6 per cent merit rate would come down to 5 per cent and the 12 per cent merit rate would come down to 10 per cent. It would meet the aspirational demands of the middle-class by bringing down the incidence of duty on a wide range of consumable products from 26 per cent to 20 per cent.

It would shore up the revenue of States by giving them an equal share in the revenue of demerit goods, instead of the cess, which would deprive them of the same. It explores a new revenue option in the form of GST on purchase of unmanufactured tobacco, which will help disincentivise the consumption of all tobacco products by raising prices, subserving the health objectives of the Government.

The only negative factor could be the rise in the incidence of duty on services from the current rate of 15 per cent to 20 per cent. This increase could be mitigated by having merit rates of duty on services, similar to goods. For example, transportation services could be subject to a uniform merit rate of 10 per cent as increased transportation costs could fuel inflation.

In conclusion, the alternative rate structure without the cess will find greater acceptance with the States besides shoring up government revenues through a marginal increase in the overall standard rate and a new GST levy on unmanufactured tobacco.

The writer is Advisor, Tax Policy Group, EY

Published on January 15, 2018

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