Can GST rate rationalisation make India's tax system truly simple?

The Union government plans to propose GST rate and slab cuts to the GST Council. Can this reform make India's indirect tax system truly simple?

Eighteen months after the Goods and Services Tax (GST) was implemented on 1 July 2017, then finance minister, the late Arun Jaitley, outlined his personal vision for the future roadmap of the country’s indirect tax reform in a blog post written in December 2018.

 

“A future roadmap could well be to work towards a single standard rate instead of two standard rates of 12 per cent and 18 per cent. It could be a rate at some midpoint between the two. Obviously, this will take some reasonable time when the tax will rise significantly. The country should eventually have a GST which will have only slabs of zero, 5 per cent and a standard rate, with luxury and sin goods as an exception,” Jaitley wrote.

 

Six years later, the Union government is in the final stages of taking a proposal to the GST Council to reduce the number of slabs and rates on many individual items based on the work of a Group of Ministers on rate rationalisation under Bihar Deputy Chief Minister and Finance Minister Samrat Choudhury.

 

Need for rationalisation

 

India’s GST structure merged 17 taxes levied by states and the Centre, thus unifying the country into a single market. Despite its advantages, India’s current GST system faces several issues. With five tax slabs (plus cesses), businesses often struggle with classification disputes. For instance, determining whether a product should be taxed at 12 per cent or 18 per cent often leads to litigation and unnecessary bureaucracy. Most goods and services fall under the 18 per cent slab, which is high compared to some countries. This not only increases prices for consumers but also incentivises tax evasion and underreporting of transactions.

 

In contrast to India’s five slabs, countries like Singapore (9 per cent) and New Zealand (15 per cent) follow a single-rate structure, while nations like Canada and the EU have dual or multiple rates but with fewer slabs than India. The EU mandates a minimum standard rate of 15 per cent, with provisions for one or two reduced rates not less than 5 per cent.

 

The Finance Ministry recently informed Parliament that approximately 70–75 per cent of the total GST revenue in FY24 was derived from the 18 per cent GST slab, while merely 5–6 per cent of revenue was contributed by the 12 per cent GST slab during the year. Only 6–8 per cent of FY24 GST revenues came from the 5 per cent slab, while the highest tax slab of 28 per cent contributed 13–15 per cent to revenues. The current exercise provides an opportunity to re-evaluate the relevance of the 12 per cent GST slab.

 

Ideal structure

 

Shivam Mehta, executive partner with Lakshmikumaran & Sridharan Attorneys, said that similar to the EU value-added tax (VAT) structure, the Indian government may consider implementing a mechanism for establishing a standard GST rate, which may be similar to the revenue-neutral rate of 15.3 per cent initially envisaged at the time of GST implementation.

 

However, Mehta cautioned that reducing the 18 per cent rate to a unified rate of 15–16 per cent would result in a significant decline in revenue for both the states and the Central government. “It is essential that such rationalisation occurs in a phased manner to prevent economic disruptions,” he added.

 

Pratik Jain, partner with PwC, said that given the current tax-to-GDP ratio, decreasing the effective GST rate may not be an option for the GST Council. “However, the rate structure can be simplified by reducing the four-tier rates (5, 12, 18 and 28 per cent) to a three-tier structure, say 6–7 per cent, 15–16 per cent and 26–28 per cent. This will reduce classification issues and would broadly align with the global system where most products and services attract a standard rate, with a few attracting a lower rate and some demerit/luxury ones attracting a higher rate,” he added.

 

According to Vivek Johri, former chairman of the Central Board of Indirect Taxes and Customs, this is the best opportunity for the government to bring items like petroleum, alcohol and real estate under the GST ambit as part of the rate rationalisation exercise. “Bringing them under GST would help the Centre garner more revenue,” he said. However, a recent attempt by the Union government to bring aviation turbine fuel into the GST fold was severely opposed by state governments, fearing further revenue erosion and a loss of taxing authority.

 

Former Jammu & Kashmir Finance Minister Haseeb Drabu also suggested merging the 12 per cent and 18 per cent slabs into a new 14 per cent slab to create a three-tier rate structure. “The government also needs to bring in real estate, power and petroleum under the GST ambit to increase their revenue. The Centre needs to re-engage with the states on this,” he added.

 

Compensation conundrum

 

The GST Compensation Cess, introduced to compensate states for revenue losses after the implementation of GST, will continue until 31 March 2026. While the original compensation period ended in June 2022, the cess was extended to repay loans taken during the Covid-19 pandemic when GST revenues fell sharply. The cess, levied over and above 28 per cent GST on luxury and sin goods like tobacco, coal and automobiles, will be discontinued once the outstanding borrowings are repaid. The Union government has set up a Group of Ministers under Union Minister of State for Finance Pankaj Chaudhary to decide on its future.

 

According to Drabu, there is no need for the GST Compensation Cess anymore, as monthly GST revenues have now stabilised.

 

“The cess was initially introduced to compensate states for revenue losses after the implementation of GST. However, with GST collections showing consistent growth, the need for such compensation has diminished,” he said.

 

According to a former Finance Ministry official, states would not want to lose the revenue they have been receiving through the GST Compensation Cess, as it has become a crucial part of their fiscal resources. “The central government cannot continue the cess indefinitely due to constitutional limitations, since it was originally introduced for a fixed period and later extended only to repay borrowings made during the Covid-19 pandemic. A new levy on demerit and sin goods, such as tobacco, liquor and luxury items, could be introduced to generate revenue for states. This would require the enactment of a new law, which would define the structure of the levy and how the revenue is shared,” he added.

 

Profiles of key state finance ministers

 

Chandrima Bhattacharya, Minister of State for Finance (Independent Charge), West Bengal  Chandrima Bhattacharya, from the Trinamool Congress, has been vocal in the GST Council against rate hikes on mass consumption items. In August last year, she opposed any change in GST slabs.  Samrat Chaudhary, Deputy Chief Minister and Finance Minister, Bihar  Samrat Chaudhary, from the Bharatiya Janata Party, is the convenor of the GoM on GST rate rationalisation.

 

Thangam Thennarasu, Finance Minister, Tamil Nadu

Thangam Thennarasu, from the Dravida Munnetra Kazhagam, represents Tamil Nadu in the GST Council.

 

Krishna Byre Gowda, Revenue Minister, Karnataka

Krishna Byre Gowda, from the Congress, has raised concerns over Karnataka’s pending GST compensation.