The finance minister has expressed his view that chappals cannot attract the same rate of duty as AC. Further, he said that different items used by different segments have to be taxed differently, otherwise the goods and services tax (GST) will be regressive. Even Arvind Panagaria has supported multiple rates and cess. So, I am worried that he may follow this wrong path with good intentions.
Let me first assert that VAT/GST is basically a regressive tax like all other indirect taxes. If one tries to make it progressive by giving exemptions and making multiple rates, he will fall in the same old trap of misunderstanding. One has to see the whole taxation structure and try to make it progressive and not just one tax. I am giving the whole logic in detail.
There has been an effort in most countries to exempt or lower the duty on food and other essentials and, thereby, reduce the element of regressivity. However, there is a great administrative cost for trying to get progressivity by rate differentiation. The advantage of progressivity gained by a whole host of exemptions, zero rating and multiple rates is almost not certainly sufficient to offset the disadvantages associated with departure from a uniform rate and comprehensive base. Exemptions and differential rates distort consumer and producer choices, make for administrative complexity (and hence increased administrative and compliance cost) and raise questions of interpretation that often must be resolved in courts.* Any equity gains from differentiation of rates are likely to be more than outweighed by the additional administrative cost entailed. Exemption introduces cascading leading to major distortion and lack of neutrality, which is the virtue of VAT. In Turkey, achieving progressivity in 1991 was done through a cumbersome mechanism that required monthly representation of receipts, their verifications, huge bureaucracy and a very high compliance costs.** The conclusion is therefore that the VAT regression can theoretically be reduced or mitigated by exemptions and rates differentiations but in practice it is impossible to apply these measures efficiently due to many factors that are unknown or sufficiently quantified, qualified or defined.
VAT is not to be seen in isolation but in combination, that is, as a part of a total tax structure along with (i) excise on luxuries and demerit goods, (ii) income tax and (iii) expenditure policy. What has to be judged is whether the tax structure as a whole is regressive or not. The combination can be made of the best qualities of all the taxes. The strength of VAT is in its ability to raise revenue, that of excise is also in garnering revenue, of income tax is in attaining progressivity and of expenditure policy is in effectuating a pro-poor direct redistribution of income and consumption opportunity. A combination will make a strong tax structure, which will serve the welfare purpose more than a messed up VAT by multi-rated distortion. Regressivity issue may be addressed better by other tax such as income tax.*** and expenditure measures. What has to be ensured is that the whole tax structure is progressive in that it raises enough revenue to make sufficient funds available for pro-poor welfare expenditure. The strength of VAT in realising revenue (if it is a simple single rate VAT with only a zero rate for export and a few exemptions) should be harnessed to combine with the progressiveness of high excise on luxuries and an effective income tax to make a progressive and buoyant tax structure. So VAT may well be regressive in the usual sense but it need not be regressive in combination with other taxes as a part of a tax structure in the more comprehensive view of things.
So, my suggestion is that though we need not have a flat rate, we should have rates: five, 16 and 26 per cent and no cess. And, no separate rates for service tax. Now that GST Council has finalised the rates as five per cent, 12 per cent, 18 per cent, 28 per cent and cess and separate rates for service tax, there will be enough controversy about classification. Maximum damage has been the creation of rates 12 and 18 where there will be most controversies. The finance minister’s assertion that several rates in GST will be a progressive tax is unfounded. Bad days back again.
* Sijbren Cnossen – Canadian Tax Journal 1987 Vol.35 May-June 1987, p.567.
** Alan A. Tait – VAT Policy Issues, Structure, Regressivity, Inflation and Exports, p.7 in Value Added Tax: Administrative and Policy Issues edited by Alan A. Tait,
IMF 1991
*** Ben J.M. Terra – Systems of Levying Sales Tax – VAT Monitor, January 1990, p.14
The writer is retired member of the Central Board of Excise & Customs.
E-mail: smukher2000@yahoo.com
