AUGUST 14, 2018

By TIOL Edit Team

THE GST Council should ponder over International Monetary Fund (IMF's) recipe for reforming Goods and Service Tax (GST), which it considers as a "milestone reform in India's tax policy".

The GST reforms have been articulated well in IMF's two reports on India released on 7th August 2018. It, among other suggestions, calls for restructuring of existing multiple rates into two rates.

In its annual publication, IMF Staff Report on India (SRI), IMF has recommended: "Continued fiscal consolidation is needed to lower elevated public debt levels, supported by simplifying and streamlining the GST structure".

SRI suggests: "Enhancing GST compliance, including by streamlining filing and refund mechanisms and simplifying the rate structure, along with strengthening tax administration, are key to relieve the burden on MSMEs and help deliver on the GST's promise of enhanced formalization of economic activity".

It adds: "Fewer rates and a broader base would limit opportunities for reclassification (to exploit rates differences between inputs and outputs) and simplify administration. In this context, consideration could be given to include petroleum products in the GST".

In the 2nd report titled 'India Selected Issues' (SIs), IMF says: "A dual rate structure with a low standard rate and an additional higher rate on select items can be progressive and preserve revenue neutrality, while streamlining exemptions would further contribute to progressivity and reduce compliance and administrative costs".

IMF's recommendations, coupled with improvements mooted by the World Bank and suggestions from other entities, constitute a compelling reason to simplify and stabilize GST framework.

GST should not be reduced to a tax that is under perpetual change. Excessive and too frequent changes in any tax framework causes business uncertainty. This, in turn, can offset or reduce potential benefits of historic reform. Well-meant reform might thus end up becoming its own enemy.

As put by a working paper (WP) on GST released last month by Indian Institute of Management, Ahmedabad, "A movement to GST merely in name but not otherwise –as when there are many rates, RNR (Revenue Neutral Rates) rates being set at the levels at which no state entity would lose, independent two tills, multiple registrations could negate all the hoped for gains."

India is among five countries having four or more GST rates (four non-zero rates of 5 percent, 12 percent, 18 percent, and 28 percent; special low rates of 3 percent on gems and jewelry and 0.25 percent on rough diamonds; and a GST cess levied on demerit goods).In comparison, among 115 countries with VATs, 49 have a single rate, and 28 have two rates.

The World Bank's biannual publication India Development Update released during March 2018 made similar observations. It also pointed out that India has the highest standard GST rate in Asia.

As put by the Update, "A Key to success is a policy design that minimizes compliance burden, for example by minimizing the number of different rates and limiting exemptions, with simple laws and procedures, an appropriately structured and resourced administration, compliance strategies based on a balanced mix of education and assistance programs and risk-based audit programs".

IMF's reforms package should not be taken lightly as an academic exercise. It has factored in Prime Minister Narendra Modi's rhetorical defence of existing rate structure. The Report thus incorporates Mr. Modi's poser: "Can we have milk and Mercedes at the same rate ?"

It also reckoned the impact of forthcoming Lok Sabha polls on the country's reforms agenda.

As put by SRI report, “General elections will be held by May 2019. Against this background, government policies have shifted mainly to accelerating implementation of ongoing reforms rather than initiating new ones. And budget pressures could increase in the coming months".

Available indications suggest that Union Finance Ministry is not enthused by IMF's recipe. Responding to IMF's reforms recipe, the Government disclosed its strategy as: "Further reforms to the GST would first focus on base broadening before considering further rationalization of the rate structure, although the pruning of the list of items subject to the top 28 percent tax rate had already effectively led to some rationalization ".

It continues: "Regarding base broadening, the authorities noted that taxing certain fuels such as aviation fuel and natural gas under the GST would be relatively easy, but including other products such as petrol, diesel, and immovable property would be more challenging as they were key revenue sources for states. In the Indian context, pruning exemptions would also be difficult ".

SIs report has rightly cautioned the Government that multiple rate structure and other features of GST environment could give rise to high compliance and administrative costs. In general, high costs may stem from four factors. These are: 1) Legislative complexity (exclusions, exemptions, deductions, rate differences, frequency of changes, etc.),; 2) Procedural requirements (such as the need for supplementary documentation); 3) Nature of the clientele—e.g., dealing with non-registrants; and 4) Verification costs—especially under high informality as exists in the country.

The Report has made an attempt to estimate the change in the incidence of the GST across household consumption quintiles if a revenue-neutral shift was made to a single rate or a single rate supplemented by a high rate on certain items.

A key finding from this exercise is that the indirect incidence of the current GST disproportionately burdens poorer households, undoing the objective behind having exemptions. The lowest quintile faces an additional 2.5 percent effective GST rate since exempt goods production cannot avail of input-tax crediting (and input tax costs are thus likely passed on to the final consumer). This indirect incidence regressively diminishes with higher consumption due to the lower share of exempt goods in the consumption basket of higher quintiles, falling to 1.7 percent for the highest quintile.

SIs report says: "A single rate thus causes the effective GST rate to rise significantly for the lower quintiles and fall for the highest. Such a profile is likely to pose political feasibility constraints. Therefore, we consider an alternative simulation where a single rate is supplemented with an additional (higher) rate to target the consumption of the higher quintiles. This enables a standard rate lower than 10 percent, helping to reduce the effective rate paid by lower quintiles ".

And last but not the least is the need to pay heed to IMF's advice for fiscal vigilance. It is needed in view of the higher-than-usual uncertainty surrounding GST revenue projections, stemming mainly from the absence of historical data on which to base projections.

The Centre has guaranteed states' annual revenue growth of 14 percent for a period of 5 years. Any shortfall on this count has to be compensated by the Centre.

The resulting additional transfer of Central resources to the States might increase Union Government's fiscal deficit.

It is here pertinent to cite observation made last month by Fifteenth Finance Commission (FFC) after its interaction with Gujarat Government representatives.

FFC chairman N.K. Singh observed: "One of big challenges Gujarat is facing is GST collections. Once the 14% guarantee as GST compensation by the union govt winds up, Gujarat will need to look at the GST collection projections seriously and tax buoyancy may become an issue ".

If GST collection is a challenge for flag-bearer of economic growth, then it might be more daunting for other States.

This challenge itself is a valid ground for embarking on one-shot reforms to simplify and stabilize GST.

We hope GST Council would ensure that the country's GST becomes a vibrant tax and does not go the Malaysian way.