After the announcement of the goods and services tax (GST) reforms, there is pervasive optimism about a spontaneous boost to consumption demand. But it is hard to miss a dichotomy between this expectation and the near-term (FY26) net revenue loss estimate of just Rs 48,000 crore from these reforms. To be sure, that is just 2.3% of the gross GST mop-up excluding cess of Rs 20.6 lakh crore in FY25. Apart from the revenue gains from a 12 percentage point increase in the GST rate on specified sin goods to 40%, and higher consumption, another factor that will apparently rein in the revenue loss is that refunds on account of input taxes could be much less in the new regime.
‘Silent Tax’ and inverted duty structures
The converse of this is that tax costs of several more industries that will now be either “exempt” or in the 5% and nil slabs will rise, rather than fall. This could eventually reflect in the prices they charge to their consumers. In particular stress would be industries suffering from inverted duty structures, where input tax credit (ITC) is limited to taxes paid on input goods, while tax content in input services and capital goods are a cost. There is also a lack of clarity on whether ITC would be available at all to items in the 5% or nil slabs, as currently such credit is denied for most items under these benign rates.
The new structure will have roughly 575 items under 5% GST compared to about 300 now. With 18% tax on many inputs, and most input services and capital equipment, a wide section of industry that will be in the low output tax brackets, but lacking full or any ITC benefit, could face extra burden. In other words, an array of fast-moving consumer goods, pharmaceuticals, man-made fibres, bicycles, and kitchenware, apart from retail health and life insurance, are going to be subjected to an indirect “silent tax” in the form of input taxes that can’t be offset. According to an estimate, if full ITC is made available to the now-widened 5% slab, the annual revenue loss would have been as high as Rs 1.5-2 lakh crore.
Unintended consequences for insurance and ‘Merit Goods’
With health and life insurance policies for individuals to be exempt from GST (as against the current 18% tax with ITC), insurance companies are reportedly worried over the prospects of the tax paid on assorted services consumed by them like agent commissions and office rentals inflating their costs. Sooner or later, the increased tax burden may force them to revise tariff mark-ups upwards (by up to 5% as per a forecast), and the resultant hike in premiums may make the net gains from the GST cut to policy holders either very moderate or non-existent. So, the very objective of GST reduction, which is to curb the ever-rising costs of these social security products and expand the insurance cover, may turn on its head. In fact, going by the principle of limiting the levy to the value added and only once on it, the right base for taxing insurance ought to be the profit mark-up or the net-underwriting income of the insurers, rather than gross premium. The government would need to keep revenue considerations in mind, but would still do well to make available full ITC to at least a select group of “merit goods” in the 5% or “nil tax” categories, and shift to “zero-rating” for retail insurance policies.