A Good and Simple Tax that's "simpler, more transparent" and which will "help us in curbing black money and corruption and reward honesty". This was Prime Minister Narendra Modi's promise in his speech at the time of Goods and Services Tax (GST) implementation in July 2017.
In his latest Independence Day speech from the Red Fort, the Prime Minister had promised us a new set of reforms to help us "build an Atmanirbhar Bharat". The aim is to unleash "significant reforms in GST, focused on three pillars, of structural reforms, rate rationalisation, and ease of living", the government has claimed.
Let us look at the current state of affairs and see if the latest promise will deliver the desired results and also assess if there could be some unintended consequences.
Focus on lowering cost of living and building ease of living
During the last few years, our households have been struggling to raise real earnings and improve the quality of their earnings. A vast majority of the formal workforce is stuck in contractual employment.
In such a situation, it is regressive to see gross GST collections increasing from 6.23% of GDP in FY 2018-19 to 6.83% in FY 2023-24. It is, therefore, important that rate rationalisation should lower the aggregate level of GST cost that households bear.
However, it is not a sin to have multiple levels of GST rates at our stage of development, as richer households have far higher ability to bear the cost of development when compared to the lower income households.
Another aspect that needs consideration is the impact of input tax credit (ITC) on effective rate that the households bear. We don't have a publicly available estimate of the Input Tax Credit (ITC) availed by businesses and that of unutilised credit. We also don't know if all the ITC claims are indeed passed on to consumers.
Consequently, we don't know the impact of GST on cost of living. It, therefore, is important that the new reforms not only deliver lower published rates but also inform us transparently about the impact of GST on our cost of living.
Input Tax Credit: Cost of complexity to cost of corruption
During his speech, at the launch of GST, the Prime Minister had called it a "Good and Simple Tax". He had referred to Albert Einstein's statement on complexity associated with income tax and had promised us that we will get one nation, one tax.
We did get one nation one tax, but it is so complex that we need specialists to ensure compliance. A recent article referred to GST as Good, not Simple Tax. Another article listed 13 hidden costs of GST regime. For instance, GST on popcorn left a bitter aftertaste, as a TNIE editorial pointed out.
A look at input tax credit (ITC) problems make us realise that ITC has not only added compliance costs for honest businesses, but it has also provided unlimited opportunities for corruption, as has been seen in multiple fake ITC claims reports.
In its pure form, ITC is expected to help reduce the cascading effect of taxation. But in its degenerate form, it can and has provided perverse incentives for the dishonest.
We also know of situations where large companies don't pay their suppliers the GST component of the invoice until they have filed their GST returns—adding to cash flow woes of small suppliers.
Eliminating ITC and making GST a simple consumption tax
We now have complete data for about seven years, and it is not difficult to assess the level of ITC claims that the industry has made by each sector.
The government can publish the ITC data and its analysis and show us the level of net taxes that have been collected by sector/industry. The Parliament and the country can then debate the level of net taxes that we need by sector/industry and determine what is required net collection of taxes for meeting the investment requirement of an "aspiring nation".
We can lower the GST rate to the current level of net collection and make it a simple consumption tax, in its truest sense, not just a slogan for an election rally. Honest businesses will collect and pay the tax and not waste their energy in making input tax claims. The enforcement machinery will be able to focus its energy on identifying dishonest businesses and leaving the rest of the country to focus on productive work.
Positive economic impact from elimination of Input Tax Credit
Eliminating ITC can have additional positive economic impact.
For example, the vast majority of workforce in India is employed through contractors, and the elimination of ITC on labour contracts will encourage firms to start taking them on their rolls. Businesses will also learn to deal with truly organised labour—an essential characteristic of a progressive society where labour is seen as a valued partner and not an economic slave.
In addition, the businesses will learn to compete on total cost, including the taxes, if any, they are paying as part of their value-chain choices.
Determining the most appropriate rate
As mentioned earlier, it is not a sin to have multiple rates. Indeed, it is not difficult to assess the amount of resources we need for investment in our future.
Let us assume that we need 6.5% of GDP in the form of consumption tax from households. Given that household consumption is 60% of GDP, the effective required rate is just 10.8%. If we add the government consumption to fixed capital formation to the tax base, the household burden will get lower.
We can then determine the rate that richer households need to bear for their higher value-adding consumption and rate that upper- and middle-income families need to bear on their everyday consumption.
Of course, an additional rate on sin or demerit goods too is no sin. And if the government believes that certain kinds of popcorn products are sin products, it must classify them as sin and levy the sin tax.
Products and services (polluting vehicles and equipment, tobacco, gambling, water- and energy guzzling or wasting equipment, etc.) that have adverse impact on human health and well-being or waste scarce resources are sin products, and, therefore, deserve more than even 28% rate. Writing for the newindianexpress.com, Sunitha Natti has provided good food for thought in her article on bringing fairness in determining rates.
Revenue sharing arrangement with states
Once we agree that GST is a consumption tax, the consuming state deserves to get 100% of revenue collected on consumption within that state. The union government must then discuss its expenditure plan with the states and negotiate its share of aggregate consumption tax. That will constitute true cooperative federalism.
In an ideal world, the union government must just collect one cess on higher GST slabs and raise the required resources without any disputes with the states, which will be the most appropriate step towards bringing transparency in government.
If the union government is truly committed to bringing transparency and lowering the cost of living and improving the ease of living and doing business, it must first treat GST as consumption tax and get businesses to simply collect and pay. ITC creates the need for building a complex compliance system and a complex compliance system not only increases the cost of compliance, but also breeds corruption.
Once we treat GST as a consumption tax, the consuming states deserve to retain their share of collection. The Centre can and must collect a separate consumption tax or a cess on top of higher-tax category goods and services.
