Nine years on, GST needs a more ambitious reform agenda starting now

The discussion on addressing its remaining shortcomings, including features adopted as compromises at the time of implementation, should start now policy pillars

The goods and services tax, hailed as a landmark reform, has truly brought considerable gains to the economy. The rate rationalisation exercise carried out in September last year has improved the structure of the tax further. In the nine years since its introduction in 2017, the tax has settled well into the financial landscape of the country. 

Despite this, the tax has belied expectations of being a “money machine”. Some bad features adopted at the time of implementation as a compromise solution are extremely difficult to remove. A country aiming to achieve developed-country status by 2047 can ill afford to ignore these shortcomings, and it should nudge GST reforms towards a more competitive system. Therefore, the discussion on the next generation of reforms should start now. 

Although, in terms of generating revenue, the performance of GST has not been impressive, the indirect benefits from the reform have been notable. First, it has successfully unified and simplified several consumption taxes, reducing both administration and compliance costs. 

Second, it has succeeded in harmonising domestic trade taxes. The reform has not only minimised the overlap in indirect taxes between the Union and the states but has also eliminated tax competition in terms of a race to the bottom and tax exportation from producing to consuming states. 

Third, it has helped to harmonise the tax structure and administration of domestic consumption tax, with a uniform rate structure across the country. Despite each state passing separate laws and rules, it has standardised them to a considerable extent.

Fourth, there are enormous gains from abolishing the multiple check posts and considerably unifying the markets in the country. This has helped reduce transportation costs and time and, more importantly, eliminate rent-seeking at the check posts. 

According to the Ministry of Road Transport & Highways, post-GST, the long-distance travel time for trucks has been reduced by 20 per cent. Equally important are the gains from cost savings from better supply chain management resulting from the abolition of branch offices, which were set up to avoid the central sales tax by resorting to consignment transfers. 

Despite these gains, the tax is still riddled with many shortcomings, which need to be addressed sooner rather than later, and these refer to measures to improve revenue productivity and to remove the remaining distortions. It must be noted that the structure of the tax was not really revenue-neutral when it was implemented and, according to the  Comptroller and Auditor General of India, the actual revenue collection in the corresponding months of 2017-18 was lower than the revenue collected from the taxes subsumed in GST in the previous year by 10 per cent. 

The subsequent changes pushing many items to lower tax rate categories further dampened the revenue collections. Although it was hoped that better compliance would enhance revenue in the medium term, it did not happen. The effective rate of tax, which is estimated as the ratio of revenue collections to private and government consumption, averaged about 8.5 per cent before the pandemic, declined sharply to 6.5 per cent in 2020-21, and thereafter increased, but has been virtually stagnant, varying within a narrow range of 9.5 per cent to 10.3 per cent. The much-hoped-for improvement in tax compliance due to its self-enforcing nature did not take place. 

A major reason for the lack of improvement in tax compliance is its partial coverage.  In 2005, Imran and Stiglitz (Journal of Public Economics, Vol 89, No 4, Pp 599-629) argued that the introduction of value-added tax in developing country settings can adversely impact revenues due to the expansion of the informal economy.   

This can happen if the expected gains from being in the informal sector are more than those from joining the formal sector.  The potential gains from joining the formal sector are lower when the coverage of the tax and the input tax credit available is partial. In India, the exemptions are wide-ranging, with 148 commodities under four-digit HSN classification, having almost 50 per cent weighting in the consumer price index being exempted.   

Besides, taxpayers with less than ₹1.5 crore turnover can pay the tax at a composite rate of 1 per cent on the turnover without availing input tax credit. The country-wise information on the range-wise turnover number of taxpayers and the tax paid by them is not available in the public domain, but in Karnataka, they constitute 93 per cent of the number of taxpayers, but account for just 6.5 per cent of the turnover and 12 per cent of the tax paid. Besides, petroleum products, widely used inputs in transportation are out of the tax base. These factors have robbed the advantage of being in the formal sector and diluted the self-enforcement nature of the tax by availing input tax credit.   

The most important shortcoming of the tax, which has not only eroded the tax base but also contributed to severe distortions is the exclusion of petroleum products from GST in favour of a separate excise duty, ostensibly for revenue reasons.  In 2024-25, excise duty on petroleum products constituted 22.6 per cent of domestic consumption taxes at the Union level, while sales taxes on these items constituted 33 per cent of domestic consumption tax at the state level. The cascading-type taxes levied at high rates escalate transportation costs and, as these are general inputs used in production and distribution, the adverse effects on competitiveness are significant. 

The pathways to reform are clear. Rationalisation to achieve two main rates is an important reform, but the difference of 13 points between the two main rates (5 per cent and 18 per cent) leaves a large incentive to misclassify. Ideally, it is desirable to move towards a single rate of 10 per cent, which is close to the present effective rate. If that cannot be done now for political reasons, one can increase the merit rate to 8 per cent and reduce the general rate to 15 per cent. 

The second major reform should be to keep the threshold at ₹50 lakh. This will enable focusing on the “whales” rather than burdening the “minnows”. Those with less than ₹50 lakh turnover constitute 93 per cent of the taxpayers but account for less than 7 per cent of the turnover.

An equally important reform is to bring in petroleum products within the purview of GST to provide input tax credit.  This will help expand the tax base in the transportation sector, presently exempted, and make the economy more competitive. 

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The writer is a councillor at the Takshashila Institution and a former director of NIPFP. The views are personal