Don't increase GST

Higher tax rates will stifle demand and growth

Goods and services tax (GST) collection crossed the Rs 1 trillion mark for the fourth month in a row. The government collected Rs 1.05 trillion in February, which was 8.3 per cent higher than in the same period last year, but was lower than the Rs 1.1 trillion collected in the previous month. While it is encouraging to see the GST mop-up stabilising above the Rs 1 trillion mark, experts note that higher collections could be a result of blocking input credit. Therefore, it will be important to see if the trend sustains in the coming months, especially after the end of the current fiscal year. Despite the improvement, growth in collection remains significantly lower than the underlying assumption. As a result, states need to be compensated for the shortfall, and this could become a source of confrontation between the Union and state governments. 

The Union government has noted that, according to the law, compensation to states can only be paid from the compensation fund. In a recent interaction with The Indian Express, for instance, Union Revenue Secretary Ajay Bhushan Pandey noted: “…if there is a shortfall which is more than what the compensation fund is giving, then the GST Council has to see what measures it can take to either increase the compensation cess amount or consider the raise.” As this newspaper reported recently, despite using the surplus from previous years, the compensation shortfall in the current year would be to the tune of Rs 28,000 crore. Since the collection of the compensation cess is not enough, the GST Council might consider raising the cess or rates. It would be well advised to not increase taxes at this point. Growth in economic activity is weak, and an increase in GST rates or cess will further stifle demand and reduce the possibility of revival. The Indian economy grew at a modest pace of 4.7 per cent in the third quarter of the current fiscal year, compared with the revised estimate of 5.1 per cent in the previous quarter. 

Further, it is important to realise that the idea of compensating states for 14 per cent growth in GST collection was unrealistic from the beginning. Therefore, the Council would do well to recalibrate the extent of compensation. It is highly unlikely that consumption tax will grow at 14 per cent when the economy is expected to grow by just 7.5 per cent in nominal terms (as in the current fiscal year) or even 10 per cent (as projected in the next fiscal year). Besides, the Council should not have lower rates, as it did on multiple occasions in the past before the system and revenue had stabilised. 

It is likely that states will not be willing to accept lower compensation because their budgets will get affected. Economic slowdown has anyway affected both the flow of central taxes to states and collection of other indirect taxes. But raising tax rates at this stage would do more harm than good. Instead, the Council should work on plugging the leakages in the GST system, which would help increase revenue. Adjusting the compensation to a realistic level will also incentivise states to do more to mobilise revenues. In the meantime, state budgets will need to be attuned to the economic realities.