PM Modi can still save big reforms; he just has to use Arvind Subramanian formula
It is more than a quarter since the biggest tax reforms in Indian history took place when the Goods and Service Tax (GST) was launched in India on July 1,2017. However, ever since its implementation, the tax reforms regime has been on the radar of government critics that the legislation has been mismanaged by the government and the Indian economy has been bleeding due to this. Even the economists who had supported NDA’s GST legislation have started to accept that Narendra Modi’s GST bandwagon is going through rough Indian roads. Big industries are worried about the complexity of the rate structure and classification of products under the tax regime originally conceptualized as ‘One nation, one tax’. Small traders are so dumbstruck looking at the convoluted structure and compliance process that many of them don’t know where they stand in the whole affair. Part of the reason for low compliance is this confusion. By now, it is clear that both the GST council and the government failed to foresee the likely hurdles before setting the ball rolling on the grand tax reform.
After a few days, Union Finance Minister Arun Jaitley promised some corrective measures to ease the pain of small entrepreneurs. A group of Ministers (GoM) set up to think of more ways to simplify the GST structure has now come up with some interesting suggestions. Part of these proposals are increasing the turnover limit to avail the composition scheme and lowering the flat tax rates on certain categories to as low as 1 percent. These proposals will be taken up in the next GST council meeting.
Obviously, the government is under tremendous political pressure to ease the pain of the trading community with the crucial Gujarat assembly elections round the corner and the Congress-led opposition taking up GST implementation flaws as a major governance failure of the Modi-government. But with six different tax slabs on GST (zero, 5, 12, 18, 28 and those with cess), it is highly unlikely that any time soon the important indirect tax reform will get the acceptability among the public for the intended reason (a simplified, lower tax regime). For this, the government needs to work with the GST council to cut the number of tax slabs to the lowest possible. In the first place, it should not have ignored the warnings and recommendations of an expert panel headed by government’s own chief economic advisor, Arvind Subramanian submitted way back in December, 2015. Had the government followed those recommendations, GST would have been less painful experience for both the government and the industry.
The important elements of the Subramanian panel were the following:
One, the CEA panel had essentially suggested a three-rate structure. A concessional rate of 12 percent for public goods that concerns the deprived or weaker sections, a standard rate of 17-18 percent that would concern majority of items and a rate of 40 percent for luxury items and tobacco, aerated drinks and pan masala, etc. In reality, the government-headed GST council went ahead with a six slab structure making the tax system complex and far from what was originally conceptualized.
Two, fix the rate on precious metals at around 15 percent, the committee said, arguing that if precious metals continues to enjoy highly concessional rates, the rest of the economy will have to pay in the form of higher rates on other goods, including the essential ones. Right now, the GST rate on gold jewelry is kept at 3 percent.
Three, the panel had clearly warned against going for panic-driven changes on the rate rules in few month after implementation. “Complexity and lags in GST implementation require that any evaluation of the GST—and any consequential decisions—should not be undertaken over short horizons (say months) but over longer periods say 1–2 years. For example, if six months into implementation, revenues are seen to be falling a little short, there should not be a hasty decision to raise rates until such time as it becomes clear that the shortfall is not due to implementation issues.” What happened in reality is contrary to what the CEA panel recommended. Just after three months of the implementation, the government is now talking about overhauling the rate structure itself.
Four, the CEA panel argued in favour of bringing petroleum and electricity under GST. “Bringing electricity and petroleum within the scope of the GST could make Indian manufacturing more competitive; and eliminating the exemptions on health and education would make tax policy more consistent with social policy objectives.” So far, the GST has kept both these outside of its purview.
Of the four important recommendations, the most critical one is to simplify the number of tax slabs into three simple categories. The government is currently changing the rules on the go that will only bring more uncertainty and hassles to the industry and confusion to investors. Applying the Subramanian formula of three rates to the GST structure could make it lot simpler and consistent with the original objective. Right now, with too many tax rates and cess burden, GST is fast losing its appeal. Modi shouldn’t let the mess worsen.