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GST News Details

A workable solution: Sharp rate hikes not inevitable to bridge GST revenue gaps

Most commentators on public finance including the Reserve Bank of India and the 15th Finance Commission have been concerned about the Goods and Services Tax debuting with a rate structure that was marginally below a computed revenue neutral rate (RNR) for a quantified base, and then slipping considerably below that level. There have been multiple rate reductions over the years as economic stimulus. So the most prominent strand of a plan to insulate the state governments from the shock caused by the withdrawal of the guaranteed State-Goods and Services Tax (S-GST) revenue is to promptly restore the RNR.

This is also expected to improve the aggregate revenue buoyancy. However, there needs to be a careful reconsideration of this strategy that involves wholesale rate hikes, for two reasons. Firstly, revenue buoyancy is not just a function of tax rate or the incidence of tax on any economic agent. After a threshold, the two have an inverse relationship and this dividing line also alters in response to the consumption-demand scenarios or price elasticity of demand. Secondly, RNR is not a constant, rather it’s constantly prone to the changes in the consumption matrix.

The consumption market is much more dynamic and fluxing now than ever before. Prime Minister’s Economic Advisory Council member Sanjeev Sanyal has therefore struck the right chord as he told this newspaper in a recent interview that the purpose of the proposed exercise to rationalise GST structure/rates “is not to increase or decrease the average tax rate, but to collect more tax revenues and to do it with the least amount of friction to the economy.” In a state of leveraged consumption—which forced the RBI to raise the risk weights on unsecured loans—higher indirect taxes should not dampen the aggregate demand further.

It is a proven notion globally that more effective than using tax rate as a tool to boost revenue is a concerted strategy to improve compliance and widen the tax base. As a destination-based tax on consumption, GST is meant to produce an “output effect” by confining tax to the value added at each stage. A virtuous cycle of incremental value creation is expected to allow progressive lowering of tax rate until a stage below which revenue indeed takes a hit.

A steady improvement in compliance in a rapidly formalising economy has in recent years quickened the pace of GST revenues after the initial disconcerting lows and the abyss caused by the pandemic. However, at 2.71%, S-GST to state GSDP ratio (exclusive of compensation) in FY23 was still lower than 2.88% in the immediate pre-GST year FY17, and far lower than what the taxes subsumed in GST fetched the states in FY13 (3.28%). That explains why a massive `8.2 trillion, or 10% of the gross mop-up was transferred to the states as compensation between FY18-FY23.

The revenue slump had to do with slower nominal GDP growth and the problems with the design and implementation of GST. The fact is GST revenue growth is plateauing, and the revenue gap doesn’t look to be bridged anytime soon in a faltering economy. This has caused several states to suffer revenue deficits again, and some stare at bigger gaps as the relevant Central grants are tapering. Addressing the structural infirmities of GST, and plugging the remaining revenue leakages ought to be the way forward. It is futile to seek higher indirect tax revenues from an economy that struggles to win its spurs.

Source: Financial Express