A GST reset: Simplify the tax structure to boost revenue collection

Ahead of the two-day Goods and Services Tax (GST) Council meeting, starting today, representatives of several states ruled by non-National Democratic Alliance parties met last week to assess the potential changes in the indirect tax system. Their suggestions, as reported in this newspaper and elsewhere, indicate that implementing the intended changes will not be easy. For instance, the group has suggested imposing an additional levy over the 40 per cent rate on sin and luxury goods. They have also suggested that the additional levy be fully transferred to states. Further, the states concerned have argued that, with 2024-25 as the base year, they should be compensated for revenue loss if growth is below 14 per cent. There are projections of revenue loss of ₹85,000 crore to ₹2 trillion because of the proposed rationalisation of GST rates. 

Prime Minister Narendra Modi had announced in his Independence Day address that the GST system would be rationalised. It was later reported that the system would move principally to a two-rate structure with 5 per cent and 18 per cent, covering the majority of the goods and services, along with a higher rate of 40 per cent for a few sin goods. It is worth emphasising that experts have long argued that the multiplicity of rates has affected the functioning and performance of the GST system. Thus, the rationalisation exercise was due for quite some time. However, the reported suggestions and reservations of some states suggest that the rationalisation of rates and slabs needs to be approached carefully. 

The idea of compensating states for a possible revenue loss, for instance, is untenable. States were compensated for revenue loss in the first five years of GST through a compensation cess. When cess collection fell short of what was required during the pandemic, they were compensated through borrowing, which is being paid by extending cess collection. Such an arrangement cannot be extended perpetually. Therefore, as the GST Council deliberates on rate changes, it would do well to keep certain things in mind. The exercise should not be approached solely as a measure to boost domestic demand through lower taxes to compensate for the potential loss of export demand resulting from higher tariffs by the United States, as some have argued. The exercise should be focused on simplifying the tax structure and improving revenue collection. As economist Arvind Subramanian and others showed in this newspaper today, the applicable GST rates are far higher than the broad rate slabs. Part of the problem will be addressed with the end of cess collection. Thus, if some types of cess are to be subsumed in the GST rates, it must be done with care. 

In terms of revenue collection, the government informed Parliament in December last year that the average GST rate in 2023-24 was 11.64 per cent, which was much lower than the revenue-neutral rate of 15-15.5 per cent suggested by a government committee. The weighted average GST rate at the time of inception was 14.4 per cent. Premature rate reduction affected revenue collection. The council should avoid repeating the same error. States have a valid argument that they depend on GST to a larger extent. Therefore, they will be better off looking for ways to boost revenue and not depend on any compensation. Both the Centre and states need to improve revenue collection to keep the general government deficit and debt on a sustainable path.