Subsuming electricity into GST

This will reduce costs for businesses, eliminate cross-subsidy and reduce the inefficiencies in the use of electricity by the agriculture and residential sectors

Improving the business environment is key to India’s development. Indian economic ambitions cannot be realized without cheap and reliable electricity for industry. According to the International Energy Agency (IEA), the electricity cost faced by the Indian industry is much higher as compared to other countries. For energy-intensive industries, high electricity prices play a crucial role in increasing their cost of doing business and adversely affecting their global competitiveness. 

One of the main reasons for the high electricity prices faced by Indian industries is the exclusion of electricity from GST. The exclusion of electricity from GST means that there is no mechanism to get an input tax refund for taxes paid on the inputs used for generating electricity. It is important to note that in India the applicable GST rate on coal is 5 per cent. In addition, 5 per cent GST is also payable on transportation of coal by trains. Since electricity is out of the purview of GST, this entire amount is passed on by generators to end consumers as power producers cannot claim credit for taxes and cess paid on coal and transportation of coal. All this leads to a high electricity tariff. 

Industries, the end-users of electricity, not only face high electricity prices but they also do not get any input tax refund for the taxes paid on electricity, which is an input in their production. It is important to note that electricity is one of the key inputs in the industrial production and no input tax credit for it ultimately makes the Indian products expensive and less competitive internationally. Besides the high electricity costs because of the no-input tax credit and cascading tax effect, industries also bear the brunt of cross-subsidy. Cross subsidization of electricity is charging higher prices from industrial users to make up for under-charging from residential consumers and agriculture. This further adds an extra layer of pricing for the industry. 

Totalling up all of these effects (no input tax credit, tax cascading and cross-subsidy) could lead to increased costs and lower margins for several industries, particularly the energy-intensive industries. For the textile industry, for example, these embedded taxes amount to about 2 per cent of the price. Therefore, it’s high time to subsume electricity into GST.

Subsuming electricity into GST will not only make the input tax credit available to energy-intensive industries but will also end the cross-subsidization of electricity prices. If electricity is subsumed under GST, then all sectors across all states will pay a uniform GST tax. Moreover, as per Article 279A (5) of the Constitution, electricity can be easily subsumed into GST without requiring any amendment in the constitution; it can be done just by the recommendation of the Goods and Services Tax Council. 

NITI Aayog has also recommended subsuming electricity into GST. Currently, the state VAT on electricity varies across states and also across sectors within a state. The think-tank has also recommended doing away with this system of differential electricity state VATs and replacing it with a uniform 18 per cent GST on electricity across all states and sectors.

NITI Aayog arrives at a 16.6 per cent revenue-neutral rate for electricity across states; this rate ensures that the country as a whole doesn’t lose on revenue if electricity is subsumed under GST. Indeed, some of the states will lose revenue if electricity gets subsumed under GST. But with any GST rate above 16.6 per cent, the center’s CGST collection from electricity will be more than enough to compensate the states for their losses. To compensate the states losing tax revenues due to this alteration, the think tank has come up with a very comprehensive three-stage compensation plan as well. With the compensation mechanism in place, no state will suffer any loss in its revenue due to the inclusion of electricity into GST.

Moreover, subsuming electricity into GST will not only reduce the cost of doing business for Indian industries but will also put an end to the massive distortions and inefficiencies in the use of electricity by the agriculture and residential sector due to the availability of power to them at either zero or very low prices. Therefore, subsuming electricity into GST becomes important.

Now, the question arises if subsuming electricity into GST can lead to such tremendous improvements in economic efficiency and ease of doing business, why has the government not undertaken this reform so far? The answer lies in the political difficulty of ending the cross-subsidy. Currently, the agriculture and domestic sectors in most states are paying either zero or very little tax on electricity; but, if electricity gets subsumed under GST, all the sectors (including agriculture and residential sector) will have to pay uniform rate of tax (say 18 per cent GST). To make this reform politically feasible, the government may consider providing direct cash transfers to farmers and poor households in lieu of power subsidies. 

Moreover, it is important to note that the existing power subsidies (for the agriculture and residential sector) are highly regressive in nature as well. Tongia (2021) argues that in India the richer households capture much more in benefits from these power subsidies than the poorest. Because upper-income households consume a lot more energy-consuming appliances and gadgets than poor ones. Providing cash transfers to the poor instead of power subsidies to all households and farmers may prove to be a better equity instrument. Therefore, we believe that subsuming electricity into GST will not only improve economic efficiencies and reduce the cost of doing business but will also help the government to more efficiently serve its equity objective.  Monika Mangla IES is Assistant Director, NITI Aayog; Dr Badri Narayanan Gopalakrishnan was formerly the Lead Adviser and Head, Trade and Commerce, NITI Aayog.

Opinions expressed are personal and do not represent the views of NITI or the government of India.