GST reforms: Some correctives a new move to strengthen the framework

The goods and services tax (GST) 2.0 unveiled by the central government has certainly simplified the rate structure and has rectified some of the anomalies – one being the inverted duty structure in the textile and fertiliser sectors. The scope for classification disputes has been significantly reduced with all food items coming under the 5 per cent rate slab instead of the earlier 5 and 12 per cent slabs.

 

However, while evaluating the GST reforms, the fundamental goal must not be forgotten. It was to raise the GST tax-to-GDP ratio by widening the tax base, by improving compliance, by ensuring a duty trail from raw materials to retail, and by including all sectors of the economy within the GST ambit.

 

In this larger objective, the failure is evident. In the pre-GST period, the GST tax-to-GDP ratio covering all the taxes later subsumed in the GST was at an average of 6.2 per cent. This has fallen to 5.8 per cent post rationalisation. This was partly due to the reduction in the incidence of duties, which fell from 14.8 per cent pre-GST to about 11.8 per cent, and now further down to 10.5 per cent after the rationalisation. This has made the task of raising the GST tax-to-GDP ratio much harder. This ratio has stagnated between 17 and 18 per cent of GDP over the last two decades. The expectation was that post GST reforms, the GST tax-to-GDP ratio would go up from 6.2 per cent pre-GST to at least 7.2 per cent. Now much of the efforts have to come from the direct tax side, especially personal income tax where there is still sufficient scope.

 

The challenge now is to raise the ratio by a combination of measures such as increasing the incidence of duties on sin goods like cigarettes, online gaming, pan masala, and high-end cars. The other measure could be to raise the duty on gold and gold jewellery to 5 per cent from the current 3 per cent.

 

Finally, the government has to seriously look at the exemption list. For example, the recent exemption given to health insurance was flawed because this would block input tax credit on input services like insurance agent commissions. The government has to convince the public that complete exemption does not necessarily mean a reduction in the product price if it involves blocking of input tax credit. In fact, all exempted items must slowly move to a level of 1 or 2 per cent rate so that manufacturers get used to the GST regime, which has become easier to navigate over the years.

 

The other problem with GST rate rationalisation is to still levy differential tax rates on the basis of value limits. This is indefensible because it creates administrative distortions and is conceptually flawed. Take, for example, the two most labour-intensive sectors of the economy – textiles and leather. Here, apparel valued less than Rs 2,500 per unit is taxed at 5 per cent and those above that at 18 per cent. Similar is the case for footwear. The logic behind this seems to be that goods consumed by the more well-to-do sections must be taxed at a higher rate. This logic is flawed, especially in the case of labour-intensive manufacturing, which the government is committed to encourage. Products consumed by the rich are produced by the poor. Higher rates, therefore, discourage expansion of these industries. In fact, all textiles and footwear must be brought to the same rate of 5 per cent, and all imported input going into these sectors must be exempted, along with phasing out of all non-tariff barriers like quality control orders. This makes eminent sense because the government is negotiating trade agreements with the United States and the European Union to improve market access for these sectors.

 

The correctives suggested would help to further improve the GST design and keep it aligned with the original purpose.

 

The game changer, however, would be to use GST to reform the land market. This would begin by bringing land and real estate (hereinafter referred to as LARE) within the ambit of GST. There are no legal impediments to bringing GST on LARE, while states can continue to levy stamp duty (albeit at lower rates) as the taxable events in both these cases are different. This principle has been upheld by the Supreme Court while upholding the aspect theory in taxation. While Singapore considers the sale of the right to use land as goods, in India we can certainly treat the right to use land as a “deemed service”.

 

For the GST levy to be effective, it must cover the whole value chain, from land to lodgings — from the development of land for construction, to the first sale of constructed ready-made properties. This is certainly legally tenable. The sale of land can be treated as the sale of the right to land as a service, and taxed. Besides creating the chain for a self-policing input credit chain, it will also curb the generation of black money income and incentivise land development instead of allowing non-agricultural land to lie idle. The GST levy will also remove the distinction presently made between construction services and ready-made property, with the former being taxed, while the latter is exempt. In order to keep the buyer of property away from GST formalities, GST payment could be made by the provider of the service under the reverse charge mechanism (the developer and the builder).

 

There would be no significant gains in GST revenues, as the revenue at the output end would be completely absorbed by the input duty credit availed on taxes levied on various inputs like iron and steel, cement, and fixtures used in the construction industry. The gains in revenues would accrue on the income tax side by facilitating better reporting of transactions at their true value.

 

A consensus on this can be arrived at with the states if they are assured of continued stamp duty revenue and if a public narrative is built around curbing corruption and black money in the economy.

 

To sum up, GST 2.0 was an important reform but needs a few correctives. The big game changer would, however, be the inclusion of land and real estate in the GST, which will spur the next generation of economic reforms. 

 

The writer is former member of the Ce­n­tral Board of Indirect Taxes and Customs