Tax revenues: Sequencing the GST reform

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Updated: December 03, 2019 1:49 AM

Structural and operational reforms—reducing number of tax slabs and broadening the base, etc—must be undertaken once tax revenues become relatively stable

GST reform, GST revenue, GST implementation GST departments, GSTR-3B, Consumer Price Index, GST allocation, GSTR-2At present, the GST Council relies on the analysis done by the “fitment committee”, which consists of the nominated officials of the Tax Research Unit in CBIC, and officials of the commercial taxes department from some states.

At last, after four months, the GST revenue has crossed Rs 1 lakh crore in November. That should bring in some cheer in an otherwise gloomy scenario. Of course, this too falls short of the monthly target of Rs 1.18 lakh crore, and immediate measures are needed to improve tax compliance. There are many stories making rounds about the ingenious ways adopted to create a parallel informal economy. Therefore, the time is opportune to identify reform areas to increase revenue productivity and minimise administrative, compliance, and distortion costs.

It must be admitted that GST implementation has important positives. The most important gain is from the abolition of inter-state check-posts. It is estimated that the long-distance travel time for goods has reduced by almost 20%. The reform has also helped improve supply chain management by not requiring the creation of branch offices to avoid inter-state sales tax. Also, the abolition of inter-state sales tax has made the tax destination-based, and reduced inequitable inter-state tax exportation. Equally important is the compliance gain due to the exchange of information between the income tax and GST departments. A major gain is the reduced distortion due to cascading. Earlier, the central excise duty, levied at the pre-retail stage, cascaded into the final retail value. Also, the state value-added tax was levied on excise duty paid value. Besides, there was no systematic mechanism for providing input tax credit between excise duty and service taxes. Thus, there was tax on tax, tax on the margins, and margins on the tax, resulting in the consumer paying more than what the governments collected.

While these are the real gains, the stagnation of revenues is a major concern. The budget estimate for 2018-19 for the central government was Rs 7.43 lakh crore—the actual collection was 22% lower at `5.81 lakh crore. In 2019-20, while the estimated monthly collection of GST is Rs 1.18 lakh crore, the average monthly collection during the last seven months has been less than Rs 1 lakh crore. The government is, thus, staring at a shortfall of Rs 2 lakh crore for the whole year.

Equally notable are the shortcomings in the structure of GST. The problem includes large list of exemptions, multiplicity of rates, and exclusion of several items of consumption from the base. All this has resulted in erosion of the base and continued distortions. The decision to exempt almost 50% of the items in the Consumer Price Index basket has narrowed the base. The exclusion of petroleum products and electricity has rendered the reform only partial as almost 43% of internal indirect taxes at the Centre, and 40% of those at the state level are excluded from input tax relief.

The tax is levied at four different rates—5%, 12%, 18%, and 28%—in addition to the special rates on precious metals (0.25%), gold (3%), and job work in the diamond industry (1.5%). A special cess is also levied at varying rates on items in the 28% category and, in the case of some class of automobiles, there is a cess of 22%, resulting in the total incidence of 50%. Multiplicity of tax rates enhances administration and compliance costs, enables misclassification, and, in some cases, causes inverted duty structure. Moreover, high tax rates on automobiles, and building and construction material at a time when demand conditions are compressed have caused further slowdown in these sectors. There are infirmities arising from the rate variations according to use of product, value of product, and lower rates on items considered as inputs as compared to those judged to be outputs. These cause distortions as well as compliance problems.

The most important measure needed, at present, is to stabilise revenues. This requires better compliance with the tax, for which the major action needed is to stabilise the technology platform. The originally proposed three forms—GSTR-1, GSTR-2, and GSTR-3B—could not be operationalised. The summary form, GSTR-3B, does not provide the information required for invoice matching. As the filing of the annual returns, too, is being repeatedly postponed, there is no mechanism to match invoices; this has given rise to a fake invoice industry. So far, 9,385 cases of tax fraud by this means have been detected, involving an amount of Rs 45,700 crore. The undetected amount would be much larger. In addition, the dysfunctional technology platform has resulted in integrated GST allocation to states in ad hoc ways, and has caused delays in refunds to exporters; small scale industry has particularly been at the wrong end of this.

Firming up the IT platform will be greatly helped if the threshold is kept at Rs 50 lakh. Data for 2017-18 from Karnataka shows that 93% of taxpayers had less than a Rs 50 lakh turnover; they accounted for 6.5% of the turnover and 12% of the tax paid. It is important to focus on the “whales” rather than the “minnows”. Second, 100% invoice matching is not followed anywhere. Korea tried to do this, but had to give up. E-invoicing could be done, but for the immediate purpose, it may be desirable to confine the matching to invoices above a certain value—say Rs 10,000.

Once, a measure of stability is brought into the revenues, it is easy to undertake reforms in the structure and operational details. Reducing the number of tax rates is important, and it should begin by getting rid of the 28% category altogether and transferring them to the 18% slab. The revenue from this category, including the cess, is reported to be 22% of the total. At a lower rate, the demand would be higher, and the loss of revenue will be lower. Simultaneously, it is desirable to prune the list of exempted goods and services. Only those that are difficult to tax for administrative reasons should be exempted, and many of the items under 5% should be moved to 12%. In fact, equity is better served through targeted cash transfers, and not by differentiating tax rates. Besides, calibrating tax rates based on consumption pattern alone ignores the employment potential from these sectors. In the next stage, the 12% and 18% categories can also be merged at 15%. This will simplify the tax system into two main rates. As the revenue stabilises, petroleum products and electricity could be brought within the ambit of GST. All these reforms should be sequenced and calibrated over a period of two-three years.

At present, the GST Council relies on the analysis done by the “fitment committee”, which consists of the nominated officials of the Tax Research Unit in CBIC, and officials of the commercial taxes department from some states. For a major reform like the GST, it is important to have a strong technical secretariat, with experts in administration, economics, accountancy, and law to present the Council with options to take informed decisions based on rigorous research. Equally important is the need to make all data that is not sensitive to enforcement available in the public domain for independent researchers. Reluctance to share the data is a major constraint for undertaking independent research.

The author is Member, Fourteenth Finance Commission & former Director, NIPFP. Views are personal

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