Single rate GST will be a fiscal catharsis

The reported news that the Finance Ministry has pressed for a single rate GST is one of the best news that I have ever read for a long time. "Flat tax revolution" as it is called has been catching the imagination of countries irrespective of continents not only for income tax but also for indirect tax.

Now coming to our own GST, there is a very dangerous sentence in the Discussion Paper which has not been noticed by analysts who have been only overwhelmed by the promised simplicity of it. The sentence is this, “For taxation of services, there may be a single rate for both CGST and SGST.” This shows that the Discussion Paper wants to keep a separate rate for services and three rates for goods. At the same time, the scheme is to subsume all taxes central and State , into one. Then why keep separate existence for goods and services? Why then separate rate? Really the talk of Goods and Services tax becomes empty if the difference remains between goods and services. Is this all that the bevy of conferences of the Finance Ministers achieved over a long time? In all countries goods and services have one rate or two or more but not separate rate for goods and for services.

 

The fact is that a departure from uniform rate of VAT does engender complications and costs for the tax administration and taxpayers alike. Taking all the countries into account, the trend towards single rate from 1990 to 2009 is as follows. In 1990 out of 48 countries, 12 countries (33 per cent) had single rate. Now in 2009, 54 per cent of countries have single rate. Notable are Bangladesh, Combodia, Canada, Chile, Denmark, Israel, Japan, Pakistan, South Korea, Nepal, New Zealand, Palestine, Peru, Sri Lanka, Taiwan, Thailand and UK. This trend seems to be due to the need for simplification realised after the accelerating process of proliferating multiple rates.

The economists are practically unanimous in arguing that single rate is better than multiple rates. The arguments in favour of the above combination, that is, against multiple rates are the following:

(i) Multiple rate structure and exemptions distort both consumer and producer choices. If the tax differs from one category to another, relative prices will change. These changes may in turn affect the quantities demanded, induce inter-sectoral movement of production factors and result in change in factor prices. Single rate does not distort the choice of consumption goods since there is no incentive on the part of the consumer to choose one commodity in place of the other due to tax.

(ii) Traders may mark up low-taxed goods to cross-subsidise higher taxed goods.

(iii) India already subsi-dies essential goods such as food, electricity, fuel, health care and public transporta-tion. It does not make sense to lower the standard rate thereafter because that only makes the picture of the subsidy more opaque.

(iv) Lower rate of tax red-uces the tax base and thereby makes the total collection less. This may end up by the government’s increasing the standard rate.

(v) Once lower rate is given to some, others will clamour for the same saying that they also deserve it.

(vi) For traders simplicity of tax and consequently less documentation is a great vir-tue. Entries are simple if the rate is one. Invoices are not to be split.

(vii) Administratively, multiple rates are more difficult to put into effect. The reduced rate on so-called necessities has led to numerous arbitrary distinctions, interpretation problems, litigation and pressure to apply that rate to other items.

(viii) The compliance cost of a multiple rate tends to be much higher than expected2.

(ix) The effect on redistribution is very insignificant.

(x) It is an inefficient way to protect the poor as it also benefits the rich.

(xi) The tax base is eroded.

The conclusion is that the welfare gain of an equalised tax rate is compromised rather than increased by rate differentiation. The arguments are overwhelming in favour of a single rate of VAT with zero rates for export and very few exemptions.

Email: smukher2000@yahoo.com