India Should Simplify the Goods & Services Tax from Five to Three Rates

By Afeena Ashfaque — 

Source: BmnNetwork’s flickr photostream, used under a creative commons license.

StatusNot Started — The current rate structure of four rates, plus a separate tax rate for gold and a zero percent rate, is overly complicated and should be simplified.

High Difficulty: Regulation, No Opposition — Changes to the Goods and Services Tax (GST) rates must be formally approved by the GST council, comprising of the finance ministers of the central and state governments. Proposals to reduce GST to three or two rates were reportedly presented to the GST council in its last meeting on December 18, 2019. However, the council took no action to address the issue.

This is the sixteenth installment in a new series of articles on the India Reforms Scorecard: 2019-2024 by the staff and experts at the Wadhwani Chair in U.S.-India Policy Studies. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and the impact such reforms can have on specific sectors or the economy at large.

On July 1, 2017 the Prime Minister Modi-led government implemented India’s new indirect tax regime, the goods and services tax (GST). The GST Act of 2017 replaced the previous system of multiple taxes levied by the central and state governments. Under the GST, taxes on goods and services are divided into five different tax rates – 0, 5, 12, 18, and 28 percent. The GST does not cover every product. Exempted products include petroleum products, alcoholic drinks, real estate, and electricity, which continue to be taxed through the states.

GST’s original intent was to introduce a single national tax rate system that can replace India’s traditionally diverse and complex tax system in which each of its 28 states had their own tax rules. The idea was to begin with five basic GST rates and additional levies, as further simplification in rates was considered too difficult. Subsequently the GST system was to be simplified to three or even two basic tax rates.

GST has been controversial since its introduction. While GST compliance has been easier for large firms, small businesses across the country have struggled to comply. A July 2018 survey conducted by the All India Trade Union Congress found that a fifth of India’s 63 million small businesses, contributing 32 percent to the economy and employing 111 million people, experienced a 20 percent fall in profits since the GST rollout, prompting large scale worker layoffs. Some of the sectors which are reportedly hit the hardest are readymade garments, gems and jewelry, leather, handicraft, and basic machinery manufacturing.

Small businesses have also struggled to keep up with the 200 plus tweaks to the GST system since its introduction, as they often lack the skills to keep up with the changes, or the financial resources to hire tax accountants. Such complications have led to a common view that while the GST is generally a good idea for India, it has been poorly implemented. This has, in turn, evoked many proposals to reduce the complexity.

One recommendation with widespread appeal is reducing GST to three basic rates. Proponents of the same include two major economists associated with the Modi government – Arvind Subramanian, the former chief economic adviser to the government of India, and Bibek Debroy, the current chairman of the Economic Advisory Council to the prime minister. Both have advocated for a GST structure with three rates of 6, 12, and 18 percent, arguing that it would make the GST more closely aligned to the original vision of a simple indirect tax regime. Major trade bodies like the Federation of Indian Chambers of Commerce & Industry have advocated for changes, including moving to a three-rate system.

India’s Fifteenth Finance Commission also seconds the three rates approach with a lower merit rate for items of common consumption, a standard rate of seventeen percent for most goods, and a higher rate on luxury and sin goods.

Common among most three rate proposals is the idea to combine the current 12 and 18 percent rates into a single 15 percent rate. However, according to India’s Revenue Department, doing so could lead to a short-term decline in tax revenues. This is because, under the current GST system, out of nearly 1,200 taxed goods, about 42 percent fall under the 18 percent tax rate, while only 15 percent of goods fall under the 12 percent bracket. This means the proposal to establish a combined GST tax rate of 15 percent will translate into a higher rate being charged on fewer goods and a lower rate on more goods, leading to an overall revenue loss, undermining the government’s deficit reduction goals. Further, Subhash Varshney, former principal chief commissioner of GST in the Mumbai circle, proposed including only two basic rates. Advocates of this proposal argue it will help taxpayers file GST returns more easily while reducing tax evasion.

The current GST rate structure is overly complicated and should be simplified. This will ensure easier filing of returns, and reduction in tax evasion, thereby boosting overall revenue collections. A streamlined GST will also benefit India’s many small businesses and contribute to reigniting economic growth, job creation, and national economic development.

Ms. Afeena Ashfaque is a Program Coordinator & Research Assistant with the Wadhwani Chair in U.S.-India Policy Studies at CSIS


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