The grand GST reboot: What to look at and where to focus
GST Council meetings often end in disagreements. But by announcing the rollout of next-generation reforms this Diwali, Prime Minister Narendra Modi has set a definitive timeframe for the Council to arrive at a consensus.
Foremost among all is the contentious issue of GST rate slabs. The Ministry of Finance wants to have just simple two rates replacing the current system of multiple rates.
Such a move may see states and the union foregoing revenue in the absence of a compensation scheme, according to a paper by the National Institute of Public Finance and Policy (NIPFP), an autonomous research institute under the Ministry of Finance.
In a paper titled How to mitigate revenue uncertainty related to restructuring the GST rate structure? NIPFP's professor Sacchidananda Mukherjee argued for an additional GST, in lieu of the GST compensation cess, on commodities that currently attract GST cess after March 2026 to generate additional revenue.
He further reasoned that if the additional GST becomes a concurrent tax like CGST and SGST, the states will receive 70.5% of the proceeds from the additional GST (50% + 41% of 50%). If the additional GST becomes a Union tax, states will receive 41% of the proceeds as tax devolution. This revenue source may help states mitigate revenue uncertainty associated with GST rate structuring.
The argument deserves consideration as GST is an important revenue source.
Why GST revenue is important
Taxes on commodities and services account for over three-fifths, or 62.3% of India's general government's total tax collections. Interestingly, GST collections comprise half of the total tax collections from commodities and services, which means GST revenue contributes more than taxes on income, property, capital and others.
Importantly, GST revenue constitutes a significant share of own tax revenue for states and hence, revenue interests of states cannot be ignored. Without GST compensation, achieving a consensus for rate rationalisation would be difficult if states forego revenue due to the change in the GST rate structure, Mukherjee noted.
The current multiple rate structure is prone to miscalculation, revenue leakages, and rising compliance costs due to frequent rate changes. Given that households' consumption patterns differ across states and regions, rural and urban, depending on people's disposal income and consumption habits, the GST rate-wise taxable values and tax liabilities also differ across states. So, rate rationalisation may have state-specific revenue impact and the question is how states' revenue can be protected.
18% slab contributes the biggest chunk of GST revenue
Price, quality, quantity, packaging and branding vary significantly depending on the segment of consumers. Depending on the purchasing power, the propensity to consume, and the preferences and habits of consumers, there's a significant variation in the products available in Indian markets. In this context, setting tax rates for heterogeneous commodities serving different consumer groups with varying income levels is a challenge and policymakers often face the dilemma of whether to tax or exempt a certain commodity.
Currently, there are seven slabs – nil rate, 0.25%, 3%, 5%, 12%, 18%, and 28%. Then there are a few specific rates like 1% applicable to tax collected at source for taxpayers involved in manufacturing, 1.5% relevant to the construction of affordable residential apartments, cutting and polishing diamond and diamond job works, 6% applicable to brick kilns, and 7.5% applicable to construction of residential apartments other than affordable residential apartments.
Lastly, selected items such as coal and lignite, tobacco and tobacco products, aerated waters, carbonated beverages, and certain motor vehicles attract GST compensation cess, over and above the applicable GST rate.
Official data based on FY24 GST collections show that 5% slab contributes 6-8% revenue, 12% slab accounts for 5-6% revenue, 18% slab provides 70-75%, 28% offers 13-15%, while others contribute 1-2%.
However, this isn't a standard breakup. As the minutes of the 45th GST Council meeting showed, 3% slab contributed 1% revenue, 5% slab 13.6%, 12% accounted for 7%, 18% contributed 61.4% and 28% 17%. Which means revenue composition across GST rates will differ over time.
The big challenge of addressing revenue uncertainties
Moreover, the composition of GST revenue across rates differs from the all-India average for states. This reinforces the fact that the revenue impact of the GST rate rationalisation varies across states, and there will be no mechanism to perceive the changes as long as revenue is not realised.
As Mukherjee observed, the state's GST revenue comprises state GST collections, and IGST settlement on the SGST account. But information on rate-wise IGST settlement cannot be assessed based on the present GSTR system. Since IGST settlement constitutes a significant share of the State GST revenue, the lack of information on rate-wise IGST settlement makes it challenging to attribute revenue realisation across various slabs.
It's also worth noting that IGST collections from a state is not the revenue to be realised in the state and will be adjusted to the destination states, where goods and services will be ultimately consumed. Similarly, the GST compensation cess collection from a state is not the state's revenue. Therefore, given the GST return system, states cannot easily assess the revenue across GST rates. Revenue uncertainties will prevail if there is any significant change in the GST rate structure from the current structure.
Clearly then, GST revenue cannot be assessed across rates with certainty. The question is how will the Council address the revenue uncertainties?
Based on NSSO's Household Consumer Expenditure Survey for 2022-23, the author assessed the distributional impact of GST for rural and urban areas across income groups. And the results show some interesting perspectives.
The balancing act that needs to be pulled off
First, it confirms that GST is progressive, the bottom 50% households and the middle 30% each bear 31% of the tax burden, while the top 20% bear 37% of the tax burden in rural areas. In urban areas, the bottom 50% bear 29%, the middle 30% bear 30%, and the top 20% bear 41% of the tax burden.
On the other hand, only 1% of total expenditure attracts a 28% GST in both rural and urban areas, while just 2% of the total outlay attracts a GST rate higher than 28% across all regions.
The share of average Monthly Per Capita Expenditure (MPCE) on food decreases among higher income households, and increases on non-food items further supporting the argument that exemptions and lower GST rates on food are contributing to the progressive nature of GST, and that higher GST rates on non-food items may help make the GST progressive.
Consumption expenditure varies in rural and urban areas and as the distribution of average MPCE across GST rates shows that 45% of total expenditures fall under the exempted to very low (5%) GST rates category in rural and urban areas. One-fourth of total spending falls under the 5-12% slab in rural areas, while in urban areas it's 23%.
Similarly, 18% of total spending in rural areas and 20% in urban areas fall under 12-18%. In both regions, only 1% of total expenditure is taxed at 28%, and is mainly on non-food spending. Only 2% of total outlays attract a GST rate higher than 28% across all regions.
Interestingly, consumers from low income groups in rural areas and high income groups in urban areas both consume more items under the exempt and exempt to 5% GST rate slabs. This only suggests that reducing the list of exempted items and/or increasing the GST rate on these items may increase the tax burden for low income households in rural areas, while the impact will differ for urban areas with some exceptions.
Therefore, any attempt to increase the GST base by shrinking the list of exempted goods may be weighed against the benefit of additional revenue generation from the rise in the GST base, versus the additional tax burden that rural consumers from low income groups must bear, the paper noted.
Further insights
Coming to the next slab of 5-12%, the share of average MPCE of consumers from low income groups is higher than high income households, so imposing a higher tax on these items may increase the tax burden on lower fractile classes across all regions.
As far as the 12-18% slab, it's progressive except for the top two fractile classes in rural areas, while in urban areas, it's progressive for about half the fractile class. Therefore, increasing rates on these items may not be regressive if designed carefully.
Likewise, in both rural and urban areas, the share of average MPCE on items falling under the 28% and above is higher for consumers in the higher fractile classes, which shows that imposing a higher tax on these items may not be regressive.
Of the 448 items covered in NSSO survey, 51 are sub-totals and totals and seven are exempted from GST. Among the remaining 390 items, 154 are exempted or attract a 5% GST. Of these 154 items, 105 (i.e., 68%) are food items, while the rest are non-food items. Seventy-four items attract a GST rate of 5% to 12%; 35 are food items, and 39 are non-food items. One hundred thirty-six items attract a GST rate of 12% to 18%; 22 are food items, and the rest are non-food items.
Three of the four items attracting a 28% GST are non-food items. Similarly, out of 10 items attracting a GST rate of more than 28%, nine are non-food items. This indicates that most items attracting GST rates of 12% or above are non-food items.
Food for thought and action
Overall, in rural areas, the average share of expenditure on food is 7% higher than in urban areas, and the share of expenditure on non-food is higher in urban areas than in rural areas. Within non-food items, the share of consumables is higher in urban areas, whereas the share in durables is higher in rural areas.
The share of average MPCE on food is higher for the bottom 50% of consumers compared to the top 5% of consumers. Conversely, the share of non-food consumption is higher for the top 5% of consumers compared to the bottom 50% of consumers.
Exempting and placing food items under the lower GST rate categories then may be justified, as it helps people from lower-fractile classes to sustain their consumption.