A progressive goods and services tax (GST) regime, even if slightly more complex, is what an unequal country like India should have
The Congress manifesto promises to work towards a single GST rate. It won’t happen anytime soon. It has also promised to bring petroleum under goods and services tax. Again, a non-starter, when petro-taxes are the single biggest flexible revenue source for the centre and states.
The two objectives are contradictory. If you want a single GST rate, bringing petrol and diesel under GST would mean creating yet another super-high rate. In 2017-18, the sector generated more than ?5.5 trillion for the centre and states. No one is going to sacrifice this booty for the sake of simplicity.
We need to differentiate between compliance simplicity and conceptual simplicity (easy to understand). The focus should be on ease of compliance. Conceptual simplicity—as the one-rate goal suggests—is not worth the effort. When you have a complex and diverse society with huge income variations, the idea of a tax rate that is the same for every product, whether consumed by the rich or poor, is bad from the point of view of political optics and equity.
One can, of course, semantically argue that the absolute level of tax on a ?20 toothbrush is lower than on an SUV that costs ?40 lakh even with a single rate, but those who buy this argument should equally be rooting for a flat rate of income tax, which they don’t. So, the first point to make about a single GST rate is that it is a bad idea for unequal India. The tax must be progressive, with a core middle rate, and two rates on either side. A fourth rate could be a very low one—say, 1%—applicable to all items of mass consumption, where collections can be through a reverse charge mechanism.
If today’s GST structure is complex, the reasons have less to do with political intent and more with the need to get all to sign up for the shift. The Congress could never get states on board for a simple reason: it made no mention of compensation for revenue losses. There was suspicion that the centre may renege on commitments, as it did with compensation for the removal of consignment tax. By hard-coding compensation into the GST constitutional amendment, the National Democratic Alliance (NDA) got states to willingly come on board and this introduced the first level of complexity and the introduction of a cess above the top rate on “luxury” items.
The next two levels of complexity came because of the need to ensure revenue-neutrality. Given the lack of knowledge on demand elasticities for hundreds of products, almost all rates were pegged using a simple formula: existing state VAT plus central excise. Then, there was the political need to exempt small businesses from compliance burdens. It is these exemptions and variations that need fixing first.
All special cases (the composition scheme, and flat rate GST without input tax credit) need to be eliminated in phases to conform with the core principles of the tax. This could take 3-5 years. The priority should be ever-improving software and cheap GST services that can make compliance a breeze even for small and micro units.
Let us consider desirability. Not all taxes are right for every kind of society. India is a low-trust society and its extreme diversity makes tax compliance difficult to enforce without a great deal of coercion. The reason is obvious: people are reluctant to pay taxes when they do not know whom they help. In monocultural countries like most parts of Scandinavia and the rest of Europe, high income taxes are the norm and people pay them because they know that the redistributive effect of higher taxes go to “people like us”, and maybe even come back to them once they get old or are unwell.
In diverse countries like India, no one can assume that the taxes collected will benefit “people like us”. Consider the political salience that the Congress generated by suggesting that the better-off south is paying for the poor in the north.
Two conclusions follow. The taxes that are easiest to collect are indirect taxes, as they are less visible, and GST is the ideal vehicle for such taxation, as it has a self-policing mechanism. Buyers are motivated to get sellers and suppliers into it because that is the only way they get input tax credits. For the consumer, the tax is invisible, merged into the final retail price.
Second, the taxes that are most resisted are income taxes, as they bite directly. Given our low-trust society, this is the tax most Indians will resent if used in redistributive exercises. Already, the government’s efforts to make Indians more income-tax-compliant have drawn howls of protest and accusations of “tax terrorism”.
Therefore, the logical way forward is to make GST reasonably progressive, and yet, easy to comply with. Income tax could be less progressive. India should aim for high levels of tax exemption ( ?10 lakh basic exemption in the next two years), and a shift towards a flat tax or dual rate regime (10% and 20%) over five years. This can be phased to coincide with GST beginning to deliver higher revenues, so that there is no loss.
The bottomline: a single-rate GST isn’t worth pursuing till India becomes a middle-income country with per capita gross domestic product of over $5,000 annually. At that stage, a single tax rate will not be resented as inequitous.