GST: What lies ahead for India's most ambitious indirect tax reform?

What lies ahead for India’s most complex and ambitious indirect tax reform — the goods and services tax or GST? It is often said that the future lies in the past. And in the last five years, since its launch in July 2017, the GST journey has been difficult for both economic and political reasons. The big question, therefore, is whether the GST can wrench itself free from the handicaps of the past and realise its inherent potential.

Hopes of a significant boost to revenues in the past five years have been dashed. Total GST collections in 2021-22 were about 6.26 per cent of gross domestic product or GDP compared to 6.22 per cent in 2018-19, which was both a pre-Covid year and the first full year after the new tax was rolled out. This is a marginal recovery, and the growth is nowhere near what was expected. The increase that did take place was also due largely to the marked improvement in the administration of the GST collections, the use of technology like e-way bills, improved coverage of business enterprises under the tax net and the plugging of the revenue leakages through invoice matching.

The Covid-19 pandemic and the consequent economic contraction must have had an adverse impact on the GST system and, therefore, on the collections. But why blame only the pandemic? Even before the Covid outbreak, distortions in the GST rates had crept in with no desire shown by either the Centre or the states to rationalise the rates or reduce the number of slabs. It is reasonable to conclude that those steps too contributed to the slow pace of recovery in the collections.

Politically, the handling of the GST administration in the past five years posed a new set of challenges. The spirit of cooperative federalism, which was at the heart of the idea of a tax like the GST, was generally missing, replaced by an acrimonious relationship where the states felt cheated. Many states have been grumbling over the way the compensation issue has been handled in the wake of the Covid pandemic, although the Centre in the last few months has expedited the clearance of all compensation dues to them till May 2022.

The problem was exacerbated when electoral calculations came in the way before the last general elections of 2019 and many rates were brought down, but few were raised. A new headache for the GST Council will be how it could resolve the tricky issue of whether the states should continue to get compensation even as the cess has been continued for about four years beyond June 2022, to help the Centre repay the loans it had taken for compensating the states during the Covid months. Ideally, thecompensation cess should have been subsumed in the existing GST tariff structure, whose benefits would have been equally shared with the states as well. But now with the cess continuing in its present form, an intense debate is likely on whether the states should get compensated for a period beyond June 2022. Even if the state demand is conceded, the failure to resolve the compensation cess issue now has weakened the GST architecture. Expect a prolonged tussle between the states and the Centre on this contentious issue. As the proverb goes, the can of the GST compensation cess has been kicked down the road.

Given this economic and political context, there are three formidable challenges that need to be handled. One, rate rationalisation will have to be on top of any agenda for GST reforms. This would mean not just a reduction in some rates but increasing the rate on others so that overall revenue growth is maintained. This goal can be achieved with relative ease and greater effectiveness if the number of slabs, currently at around five, is reduced to just three, as was recommended before the launch of the GST in 2017.

Two, the question of including petrol and diesel within the ambit of the GST will have to be settled. Contrary to the general belief that bringing these fuel products under the GST could create problems, their inclusion would significantly reduce the cascading effect of taxes on products and services. Petrol and diesel are used in most goods and services, but because they are outside the GST, the taxes paid on them do not get set off against the final tax. It’s true that the inclusion of these two fuel items would initially necessitate a special duty slab to ensure that there is no revenue loss for the Centre and the states. But this would not affect the revenue flow. The loss of revenue by way of set-off amounts would be a temporary phenomenon and the overall efficiency gains should make good that initial shortfall. There will also be no legislative amendment required to bring about this major change in the GST structure, since that decision has been entrusted with the GST Council through the original amendment of the Constitution in 2017. So, why delay this obvious reform?

Three, there is a need for a new compact between the states and the Centre on the question of GST. Recent developments at the GST Council indicate how many states are beginning to show a lack of trust in the way the Centre has tackled many contentious issues, including those on compensation or fixation of tariffs. If the GST Council must succeed in resolving all the major issues of rate rationalisation, reduction in the number of duty slabs and inclusion of fuel products within the GST, then the Centre and the states will have to be more constructive and cooperative. And that initiative must come from the Centre and the states will have to respond positively.

Without these changes, the continuation of a business-as-usual approach can undermine the GST’s ability to either raise revenues for the government or improve the ease of doing business. If the latest estimate of an average monthly GST collection of Rs 1.3 trillion and the finance ministry’s estimate of Rs 258 trillion as the nominal size of the economy in the current year are anything to go by, the share of GST collections in GDP should see a decline to about 6 per cent in 2022-23.