Perspective of GST as regressive tax

In the popular parlance, it is a practice to consider VAT/GST as a regressive tax compared to Income Tax, which is a progressive tax. This understanding gives a reason to the administrators to introduce GST but have reduced rates of some of the essential commodities such as food, clothing, and medical benefits in order to make the GST rates pro-poor, in the eye of the poor. But this is not the whole consideration. It is only an apparent and partial view and many more aspects need to be taken into account. While expenditure on GST by families in relation to their income is the usual way to measure regressivity, there are other ways of measuring the aspect of regressivity, namely, in comparison to the total consumption by the family and in comparison to their lifetime income.

It is regressive only if GST payments are expressed as a percentage of income. It is not regressive if payments are expressed as a percentage of consumption. If consumption is used as the denominator, then by definition the impact would be proportional. The burden of a GST levied at a uniform rate would also be largely proportional if the denominator were lifetime income, rather than annual income, because many income recipients are only temporarily in the lower income brackets. They move into middle- or upper-income brackets as their earnings increase1.

The result of the studies in Denmark, the Netherlands, Sweden and the United Kingdom on the comparison of regressivity in relation to income and proportionality in relation to consumption is the following. When measured in comparison with consumption, VAT is roughly proportional in Sweden and Denmark and slightly progressive in the Netherlands and the United Kingdom. However, when measured in comparison to income, it is regressive, but only marginally regressive in the Netherlands and the United Kingdom. The Netherlands and the United Kingdom have mitigated the regressivity by exemptions and zero rating. Particularly, the United Kingdom has widely used exemptions and zero rating for this purpose. The result is that the VAT in the UK is less regressive even measured in usual terms.

Thus, it is clear that regressivity even measured against income, which is the usual pattern, is softened by removing food and medicine from VAT/GST base, or by making refunds to low-income taxpayers2. It is widely believed, which is not wrong, that as long as foodstuff, rent and similar expenditure are taxed at a reduced rate or exempted, some progressivity might be achieved for lower-income groups3. That some progressivity is achieved by exemptions to the goods consumed by the poor is well accepted. There have been studies for other countries, which show that the rate differentiation can substantially reduce the harm that low-income groups suffer from a single rate. But there is considerable cost4 inherent in such effort, both in terms of loss of revenue and in terms of higher administrative cost and compliance cost.

The more relevant and significant question to ask is not whether GST is regressive but whether GST is more regressive compared to the alternative indirect taxes, namely retail sales tax, excise and turnover tax (not income tax because that is a direct tax). Generally, all indirect taxes are regressive in the usual sense mentioned above. But GST is just as regressive as excise duty or sales tax and turnover tax and not more than that.

GST is to be seen as part of the total tax structure. It is potentially an incomplete analysis to consider GST as regressive as a standalone tax, that is, in isolation. It is not to be seen in isolation but in combination, that is, as part of a total tax structure along with (i) high GST rate on luxuries and demerit goods, (ii) income tax (iii) expenditure policy and (iv) subsidy. What has to be judged is whether the tax structure as a whole is regressive.

The conclusion is that in the usual sense, GST is regressive but not if a total view were taken of the tax structure in which GST is one element. It is also not more regressive than all other indirect taxes. It can be made less regressive by giving exemptions and lower rates for items mainly consumed by the poor and imposing higher taxes for goods for conspicuous consumption.

1 Sijbren Cnossen – Key Questions in Considering Value Added Tax for Central and Eastern European Countries-VAT Monitor, November 1992, p.7.

2 M.L. Weidenbaun – VAT - Orthodoxy and New Thinking, P.8.

3 Dieter Pohmer - Value Added tax after ten years: The European experience in Comparative Tax Studies edited by Sijbren Cnossen 1983, p.243

4 Sijbren Cnossen—Canadian Tax Journal 1987 Vol –35 May-June 1987,p567

The writer is member, Central Board of Excise & Customs (retired)

Email: smukher2000@yahoo.com