Reforming GST

It should be a priority after the elections

One of the most significant reforms of the last decade has been the implementation of goods and services tax (GST). However, due to a variety of reasons, its performance has been underwhelming compared to the initial expectations, and the economy has not benefited to the extent envisaged. Tax collection increased in recent years, and there is scope for significant improvement. Although the GST Council drives GST-related decisions, the next Union government, irrespective of political composition, must initiate pending reforms. GST 2.0 must not only aim to increase tax collection but also improve the overall indirect tax administration, enhancing the ease of doing business in the country.

Overall gross GST collection in 2023-24 improved by 11.7 per cent to Rs 20.18 trillion. The collection, based on the second advance estimate of gross domestic product (GDP), was 6.86 per cent of GDP. Net of refunds, the collection amounted to 6.13 per cent of GDP, which is an improvement over the previous year. Revenue collection, however, must be evaluated based on taxes included in GST. General government revenue collection from taxes subsumed into GST amounted to 6.3 per cent of GDP in 2016-17. The present performance would have appeared more disappointing had cess collection been discontinued in accordance with the original design of GST. The cess was collected to compensate states for revenue shortfall at a predetermined growth rate in the first five years of implementation. However, the collection of cess continued after five years to repay the debt incurred to compensate states during the pandemic. Net of refunds and cess, GST collection drops well below 6 per cent of GDP.

There are several reasons — including premature rate reduction for political reasons — why the GST system has underperformed. The multiplicity of rates also created plenty of confusion, and duties were inverted in many cases, which affected revenue over the years. Issues related to information technology and compliance have been addressed to a large extent, but they cannot compensate for basic design flaws in the system. A Reserve Bank of India estimate in September 2019, after multiple rate adjustments, showed that the effective weighted average rate declined to 11.6 per cent compared to 14.4 per cent at the inception of GST.

The priority for the next government thus should be to nudge the GST Council to adjust to the revenue-neutral rate. This should be achieved simultaneously with rationalising slabs. Most goods and services should be brought under a single rate. Only a select few essential items may be subject to lower rates, while “sin goods” could be taxed at a higher rate. The Council should also find ways to bring petroleum products under GST. Another issue that the GST Council would have to consider, irrespective of other reforms, is the treatment of cess. While the imposition of cess has been extended till March 2026, analysts believe the debt raised to pay compensation will be repaid sooner. One view is that the cess can be subsumed into GST rates. However, this will not be appropriate and will go fundamentally against the initial promise of GST. While there is indeed a strong case for increasing GST revenue, it should be achieved by addressing the basic design flaws in the system. Taxing certain items at exorbitant rates would be contrary to the basic idea of GST.