Finance minister Arun Jaitley is right when he said, in Parliament on Wednesday, that it is a luxury to be a former finance minster since, while P Chidambaram took the high moral ground in asking for capping the standard GST rate at 18%, none of the state finance ministers are ready to agree to the formula suggested by the chief economic advisor—his revenue neutral rate of 15-15.5% roughly corresponds to a standard rate of 17-19%. Which is why, after the Constitutional Amendment Bill on GST was passed, Kerala finance minister Thomas Issac said that even Congress-ruled states would not agree to a cap of 18% on the standard rate. So while the Congress may try and score points with the reform lobby and the common man in asking for a cap on rates, the fact is that if Jaitley does not go with the state finance ministers, he will have no GST. So the best that he can do is to keep appealing to them and hope that they will agree to lower rates over a period of time. Indeed, that is why the scheme of the voting in the GST Council where the centre has a veto over potentially bad policy decisions is very well designed.
Will states agree to lower rates, as the finance minister seems to be suggesting will happen over a period of time? His argument, though not explicitly spelled out, is that as collections start rising and states see the benefits to be got from GST, they will be amenable to lower rates. The evidence from VAT doesn’t suggest this is automatic. In most states, the lower rate has crept up from 4% at the time VAT was implemented to 5% today, and in the case of the standard rate, from 12.5% to 14.5%—in Gujarat, the standard rate has gone up to 15%. And that’s despite compliance rates going up. Between FY10 and FY14, according to the old GDP series, VAT collections rose 2.1 times versus nominal GDP rising 1.8 times; between FY12 and FY16, which is the new series, VAT rose 1.7 times versus 1.6 for nominal GDP.
In order to justify a higher rate—the GST FAQs issued on Wednesday worked on a hypothetical 20% rate!—Jaitley argues that 85% of central excise duties are at the standard rate as are 62% of VAT collections, implying that the bulk of goods pay a 27-28% tax rate even today. While that suggests that even a 20% standard rate is a good thing, that’s comparing chalk and cheese. For one, the excise rate is charged at the factory gate, so if you keep in mind a 40% post-manufacturing value addition, the GST equivalent of the excise rate will be around 7.5%—once you include the standard VAT of 14.5%, this means a standard GST rate of around 20% isn’t much of a cut. In the case of services, moving to a 20% rate is a big jump especially if you account for the rampant evasion today. Since there is little Jaitley can do about this, if the Congress does launch a successful campaign to shame states to accept an 18% rate, that can only be a good thing.