Addressing uncertainty

Necessary changes in GST must be made in time

The completion of five years of goods and services tax (GST) in a few months will trigger a big structural change in the system. States were promised compensation against the shortfall in revenue with a growth assumption of 14 per cent for the first five years. With the completion of five years, the states will no longer be compensated. As noted by Union Finance Minister Nirmala Sitharaman this week, the compensation cess on GST will continue, but the proceeds will be used to repay the loans taken to compensate states for the revenue shortfall during the pandemic period. The compensation cess was not sufficient to adequately recompense the states for the shortfall in revenue collection due to the pandemic-induced disruption. The removal of compensation from the GST framework, which is expected to happen by design, will create significant uncertainty for the states, particularly at this point when economic activity is weak and states are expected to reduce their budget deficits.

GST was introduced with multiple objectives. Among other things, it was expected to reduce complications in the indirect tax system, contain tax evasion, and boost revenue and economic growth over time. However, it is clear that the GST system has underperformed and needs to be fixed to attain wider objectives. To be fair, both the Union and state governments have worked through the GST Council to improve the GST system over the years. Compliance seems to have improved, which has resulted in higher revenue over the past several months. However, overall revenue collection has underperformed, which has affected government finances, particularly at the Union level as states were being compensated. Now that the provision of compensation will end in a few months, state government finances would also come under pressure.

It has been argued by some states that the provision of compensation be extended. However, this would be difficult to implement because the cess will remain beyond June 2022, and will be used to repay the loan. Thus, to compensate the states for their revenue shortfall, additional cess might need to be imposed, which will further complicate the GST structure. The Council will, therefore, need to find more permanent ways to address the revenue issue. One of the reasons why revenue collection has underperformed is the premature reduction in rates. In this context, the group of state finance ministers is reportedly expected to recommend increasing the 5 per cent slab to 8 per cent, which is projected to increase revenue collection by Rs 1.5 trillion annually. The group of ministers in its report is also expected to recommend the removal of items from the exemption list, along with a reduction in the number of slabs. These are sensible things to do and will help take GST to the revenue-neutral level.

This GST Council would be well advised to make all the necessary changes in time to avoid uncertainty. A broader consensus, to be fair, will be needed to change the tax structure. The Council should also take this opportunity to review operational issues in the GST system to improve ease of filing, which will help boost compliance and revenues. The need for boosting tax revenue cannot be overstated at this stage. India’s debt-to-gross domestic product ratio has increased substantially and the government needs to spend more to support the ongoing economic recovery.