Structural changes in GST

Correction to revenue-neutral rate must not be delayed

The Goods and Services Tax (GST) Council’s 45th meeting in Lucknow last week took several important decisions and set the ball rolling for two structural changes. The council extended concessional rates for several drugs, such as Remdesivir, used to treat Covid-19. It also reduced duty on some other drugs like Itolizumab and Posaconazole till December. Since the pandemic is unlikely to end by December, the council could have easily extended the concession at least till the end of this fiscal year. It further decided to correct the inverted duty structure in textile and footwear, which was discussed in earlier meetings. Additionally, the council decided to form two groups of ministers to examine the issue of inverted duty structure in different sectors and using technology to improve compliance. The findings of these groups should help streamline the GST structure and improve compliance, resulting in higher revenue collection over time. However, making online food-delivery firms pay GST on behalf of restaurants will end up increasing the compliance burden and should have been avoided.
 

Apart from operational matters, Union Finance Minister Nirmala Sitharaman talked about two important structural issues. First, the minister said the compensation to states would not be extended beyond June 2022. At the time of implementation of GST, it was decided that states would be compensated for shortfall in revenue collection with an annual growth rate of 14 per cent for five years. Some non-National Democratic Alliance-ruled states have argued in favour of an extension. A guaranteed compensation factoring in 14 per cent revenue growth per year was an impractical idea from the beginning. The assumption was that GST would boost revenue, which has not materialised. States are being compensated for the shortfall by market borrowing for the second consecutive year, which will be repaid by cess collection beyond June 2022. Extending the compensation mechanism beyond June 2022 will further complicate the GST system since compensation cess collection will be used to repay debt. Any extension in the collection of the compensation cess itself will affect items on which it is levied and firms will have to alter business plans.

The basic structural problem is lower revenue collection, and this is where the second issue underlined by the finance minister becomes important. Ms Sitharaman noted the revenue-neutral position at the time of implementation was about 15 per cent. However, the rate has come down to 11.6 per cent. Clearly, premature rate reduction, largely because of political reasons, has resulted in lower revenue collection. As the Fifteenth Finance Commission report showed, revenue from GST was lower by well over 1 per cent of gross domestic product in 2019-20, compared to the collection from taxes subsumed into GST in 2016-17. Thus, the council should target reverting to the revenue-neutral rate as soon as possible, along with reducing the number of slabs. Extending compensation for revenue shortfall is not a lasting solution. Lower collection also affects the central government finances and has an additional indirect impact on states in terms of lower transfers. Thus, the council should now work on strengthening the GST system. Lower overall GST collection is one of the reasons why dependence on petroleum products for revenue has increased and they cannot be brought under GST.