While finance minister Arun Jaitley tries to get various state finance ministers to agree to a low ‘standard’ rate—the panel headed by chief economic advisor Arvind Subramanian was in favour of a 17-19% rate while most states want 23-24% —in the first GST Council meeting over the next two days, he needs to use the same logic that helped convince producer-states to give up their demand for a 1% tax on inter-state transactions. And that relates to the central government promising to compensate states fully for any loss in tax revenues for the first five years of GST. As long as the Centre was not going to compensate states for their loss in revenues, they were justified in pitching for a higher rate, but once their losses are made good, they can just as well agree to the 17-19% rate. And since the CEA’s panel has said a 1% increase in the ‘standard’ rate will lower compliance by 1.22%, states would do well to adopt the lower rate—increased compliance, the CEA’s estimates are, will fetch an additional Rs 4.3 lakh crore of extra taxes for the Centre and states to share. Apart from the BJP-ruled states, Jaitley can also count on the support of the Congress-ruled states since the Congress party had made an 18% rate an article of faith and was initially threatening to not support the constitutional amendment Bill if the rate was not a part of it—the finance minister needs to remind the Congress of this.
A higher ‘standard’ rate can coexist with lower rates for goods in the CPI basket—to keep the headline inflation low—but Jaitley needs to remind state governments this will necessitate very high rates on products like consumer durables and automobiles which will hit the middle classes badly; the costs of services will also rise sharply with a higher ‘standard’ rate. Apart from the fact that Jaitley will have to phase out central exemptions which form the bulk of exemptions—these total a whopping 2.7% of GDP across the Centre and states—he will also need to take the lead in hiking taxes on gold. Though 80% of gold purchases are by the top 20% of the population, gold purchases are taxed at a mere 1-1.6% today—if gold GST is raised from 2% to 6%, the standard rate can be lowered by almost one percentage point.
Jaitley may be tempted to allow state governments the exclusive rights to tax firms with an annual turnover of under Rs 1.5 crore as a gesture of good faith, but he has to keep in mind this may add to taxpayer pain and also implies giving up 85-90% of the taxpayer base. Also, while states argue that this will ensure small entities do not have to face dual control of taxmen from the Centre and the states, entities in the service sector face dual control even today since the tax threshold is a mere Rs 10 lakh—also, once GSTN is functioning well, there should not be too much of a problem. Indeed, any entity that sells across borders, whether local or national, will need to get credits transferred through IGST where, in any case, the Centre is involved. If indeed states are to be given exclusive control of entities with an annual turnover of under Rs 1.5 crore, the Centre must get it for those whose turnover is higher than Rs 1.5 crore.