Good enough vs ideal: Incremental GST reforms may outshine rapid changes

The work of reform is never finished. Last month, economist M Govinda Rao made an eloquent case in a column published in this newspaper for reforming the Goods and Services Tax (GST), both in terms of its direction and timing. He argues that the time for big reform is now, as the economy seems to be doing fine despite global headwinds. Never mind that in democracies, deep reform is undertaken only during a crisis. He also believes that our current GST structure is “sub-optimal” and must be moved in the direction of global “best practices”, “lower and less differentiated taxes, and a simple and transparent structure”, among other things.

Nobody can quarrel with this, for it is what most economists would want. Those who are more concerned with redistributive justice may not quite agree, but we will come to that later.

Soon after Dr Rao’s column appeared, we saw a practical demonstration of the GST scheme’s complexity from a Coimbatore-based hotelier, D Srinivasan, who highlighted the idiosyncratic rate structure in his business. At an event where Finance Minister Nirmala Sitharaman was the key invitee, Mr Srinivasan pointed out that GST on sweets was 5 per cent, 12 per cent on savouries, and 18 per cent on cream-filled buns, but buns themselves were GST-free.

This statement drew a lot of outrage politically, not least because a local Bharatiya Janata Party functionary leaked a video showing the hotelier apologising to the Finance Minister for embarrassing her in public, but this is not about who may have offended whom. It highlights a standard classification problem under the harmonised system of nomenclature (HSN) codes, where bureaucrats have to decide which item to put under which classification, especially when there are multiple rates.

The hotelier should be thanked for drawing attention to this problem, but it would be foolish to assume that imperfect classifications can be remedied by a few tweaks to GST rules and laws. The underlying problem relates not to economics, but to the fact that an exempt item can have many uses, and when human judgement is added to the mix, there will be an attempt to privilege or protect one group of producers and customers over others who can afford to pay more. After all, there are plain buns priced at ~5 and others costing 10 times as much. It burns up some social justice warriors if both pay no GST.

This brings me to the core of what I want to highlight. Economists (some of them at least) may want simplicity and efficiency to drive tax policies, but in a political economy there are those who want these policies to aim for redistributive justice too. Simplicity and fairness work in opposite directions. Put simply, every policy has two components, one which seeks to comply with the laws of economics, and another which has an ideological imperative. Most societies settle for compromises.

Before we address that elephant in the room, let me also point out that complexity can be handled very well by good quality software and technology. If buns attract zero GST and cream-filled buns 18 per cent, it will make no difference to Mr Srinivasan’s life if compliance complexity can be handled by good technology. As for the end-customer, it is the final price that matters, not the details of the tax component in the price. This is one reason why the very high share of central and state taxes on petroleum products makes no difference to demand, even though more and more people are becoming aware of the high tax component.

While many countries opt for a simplified tax structure, the world’s most dynamic economy, the US, not only has a multiplicity of income and product taxes at federal, state, and county levels but also stringent compliance regimes that make the Indian GST system seem like a picnic.

In a GST Council populated by states run by different political parties, incrementalism will be the norm. Also, there is the counter-argument: If it ain’t broke, why fix it? As things stand, GST has been delivering both good revenue growth and economic efficiency gains (consider the faster turnaround times for inter-state goods movement after the demolition of octroi and other barriers, for example). Warts and all, most businesses have made peace with GST. Any new move to radically change things would — at least temporarily — disrupt a system that is working. Whatever has to be done has to be done with great care and circumspection. What if, after moving towards fewer rates and limited exceptions, we find more disruption than revenue growth?

Simplicity and efficiency need not be the only goals worth aiming for. If that were the case, we should be asking for flat income tax rates instead of the current multiplicity of rates and exemptions, though the new tax regime takes significant strides towards simplification.

If we want progressive taxes on income but regressive (single-rate) ones for indirect taxes, what really are we trying to achieve? We need to work towards a regime that works in our culture, and not one that is driven by ideology or theory. If progressive (but simpler) GST rates deliver decent revenues, then so be it. One should not abandon it merely because theory suggests that one is best served by a single GST rate.

A progressive GST is the only thing we have that is close to an expenditure tax. It is also the only tax the rich farmer pays to the exchequer despite receiving many freebies.

Incrementalism is not a problem, provided the rate of improvement is faster than the rate of accumulating problems. We must reform GST steadily, one product group at a time, and we should not worry about a progressive rate of GST just because theory says that it must be more efficient. If people are willing to pay more indirect taxes on luxury goods, why should they not be made to do so? What do we gain by making luxury products cheaper in a country with so much inequality?

Our guiding principle in taxation should be driven by the principle of what works, not what is theoretically the best idea. The good enough should not be made the enemy of the ideal.

The author is a senior journalist