News Update

Indian GST - Flaw in Design - 'Hurricane Katrina' in the making!

TIOL - COB( WEB) - 680
OCTOBER 10, 2019

By Shailendra Kumar, Founder Editor

IT is downturn time, not only for the Indian economy, but the entire world economy. Trade unilateralism has aggressively been substituting the high degree of multilateralism which was achieved prior to the Economic Meltdown in 2008 through the WTO. A good number of trade blocks have come under existential crisis. Though some of the leading ones continue to hold on for the world at large but their Members appear to be responding more to counter-measures being initiated by their trading partners. India's exports is naturally down. It is negotiating tooth and nail with the USA trade representatives which seem to be following a calcified trade policy to earn lower tariff benefits for their leading exporters. India is trying hard to balance the trade offs in such a deal in the light of its own 'Make in India' policy.

For all the governments across the world, the present time is perhaps the worst economic slowdown in living memories. And all of them are under pressure to reign in public debt to more acceptable levels. Undoubtedly, revenue collections are going to be much dismal from both the GST / VAT (because of lower consumption) and corporate tax coupled with personal income tax because of poor profitability. A good number of corporate taxpayers are going to carry forward their losses. Salaries are not going to go up and thus, adversely impacting the personal income tax. Unemployment is predictably going to be the highest as a good number of manufacturers would be going slow on their outputs for lack of demand. India's automobile and FMCG industries are live examples.

In this background, when the Union Finance Minister, Ms Nirmala Sitharaman, unveiled a new corporate tax regime for India Inc, costing the Exchequer to the extent of Rs 1.47 lakh crore, she came under scathing criticism from a good number of experts. Though what she gave away was conditional and a neutralising measure for the revenue foregone in terms of exemptions and deductions ( See Cob(Web) - 678) but, most economists would agree that dealing with a sticky economic crisis like the present one, requires a balancing act. Ideally, it should be a combined reform of direct as well as indirect taxes. During downturn time, income tax should be reduced and indirect tax should be hiked to balance the dip in the revenue. There are empirical studies which indicate that if GST rates are raised during such period which would adversely impact consumption but would also encourage savings and investments - much-needed for the slowing economy. Thus, GST becomes more pro-growth than a corporate or income tax. But this is not to say that the reduction in the corporate tax rate by Ms Sitharaman would do no good! It will have salubrious effect in the long-run!

However, such a fiscal decision of any government would also give rise to a very common bogey of regressivity of the VAT system. But there are empirical studies which were conducted in many countries like New Zealand and EU Members where it was found that any hike in the GST rate may not necessarily be regressive. It affected the rich consumers more as their spending on consumption was more than that of the poor. It is equally true that such studies may not be equally valid for all economies. It depends on the local socio-economic ground realities. Since basic food items are generally exempt, any hike in the GST rates for other consumer durables or other commodities may not impact the poor. In such a background, what India needs to do is to think in terms of a mid-course structural reform of the GST system. The present crisis period is perhaps the best time to undertake the second round of reform in the GST design. And a political support for such an action is not too unrealistic to seek.

Let's take a look at what some of the State Finance Ministers have recently commented. Dr Thomas Issac is of the view that poor GST collections are because of messy tax administration. He says that the rates of several commodities have been brought down to less than revenue neutral rates. The Punjab Finance Minister, Mr Manpreet Singh Badal, is of the opinion that the current system is badly designed (See our 'Jest GST' Column). The West Bengal Finance Minister, Dr Amit Mitra says that ours is not a perfect GST and he favours a fresh rejig of the tax rates before States tumble down from cliff. He refers to poor revenue collections from 5% and 12% slabs.

In a nutshell, neither the Union of India nor the States are happy with the present design of the GST which has failed to garner revenue even up to the monthly benchmark which broadly represents the revenue neutral collections. In this backdrop, it is perhaps the right time for the Union Finance Minister to set up a panel to revisit the design of the GST and the new design should give due attention to the globally-proven principle - Multiple rates and too many exemptions compromise the efficiency of VAT system and it enhances complexity, compliance costs and administrative hassles. The present storm of GST-related frauds is a live example of poor efficiency of our GST system. What showcases the glaring flaw in our design is the fraud like the one detected yesterday where two businessmen committed ITC fraud on goods worth over Rs 900 Crore. Fraud under GST is one distortion which can be cured only through simple compliance system and certainly not administratively! VAT is a beautiful system as long as due attention is given to its simplicity. It is easy to collect and the marginal cost of its higher collection is generally negligible provided it is kept at arm's length from complexity which results in widespread complicity.

The second wave of reform should focus on four cornerstones of a modern and progressive VAT system - efficiency, tax neutrality, simplicity and fairness. If we manage to balance them well, our GST would automatically align with the OECD VAT Guidelines. If we manage to infuse these four elements in the Indian GST, there is no stopping to its contribution to the GDP by more than one per cent increase. Efficiency in a VAT system generally comes from optimisation of tax rates and minimisation of exemptions which presently appear to be infusing serious cascading in our design. One good example is China. In 2018, China simplified and unified its rates into three-tier rate structure. It raised the lower rate to 6% and reduced the maximum to 16% and thus reduced the gap between the rates which clearly enhanced the compliance efficiency in the system.

What can bring in the principles of simplicity and fairness in our GST design is the unification of thresholds for goods and services. At present, we have Rs 40 lakh threshold for goods and Rs 20 lakh for services. Ideally, small service providers or traders or manufacturers should be left out of a good GST system and the law makers should wait for them to graduate to the GST threshold level but just to appease our States and their tax administrations, we have kept very low thresholds. This has resulted in compliance nightmare for small business entities. Secondly, State GST administration continues to view them through eyeballs of sales tax regime where facilitation was an alien expression! It is high time that the GST Council led by the Union Finance Minister starts contemplating the second round of reform in the GST design which has given birth to a hurricane of litigation. This indeed reflects poorly on the intent of the political class which has, the Centre as well as States, come out with some sort of amnesty scheme to liquidate past litigation cases. What purpose will it serve if old cases are liquidated but the flood of new cases is not stopped before they become a 'Hurricane katrina'!