Five years of GST: The still good, but not-so-simple indirect tax

The GST is still paying the price for govts talking the talk of a good and simple tax on July 1, 2017, but not walking the walk thereafter

The present should not obscure the fact that democratic politics, parliamentary democracy and respect for tradition were at their finest display under this government. And the ‘good and simple tax’ — as the GST was christened by the Prime Minister on July 1, 2017 — was the cause and beneficiary.

The agreement on goods and services tax (GST) required compromises between political parties and between the centre and states. Securing them probably required deploying the full Chankaya arsenal of “saam-daam-dand-bhed”, which Arun Jaitley did successfully. It was politicking and statecraft at its glorious-grubby best.

Then there was the parliamentary debate itself. Two finance ministers, two constitutional lawyers, two veteran politicians — Arun Jaitley and P Chidambaram — went at each other with argument and counter-argument, thrust and parry and all about substance, without descending to ad hominem invective. And all the representatives of that august body contributed substantively to that long and rich discussion.

As a result, from divergence, even deep divergence of views and interests, emerged unanimity in passing the Constitutional Amendment Bill: 410-0 flashed on the Lok Sabha voting screen at that historic, spine-tingling moment, combining democratic magic and economic reform.

At the GST’s formal inauguration, the audience included many of India’s intellectuals and policy-makers who had worked on the GST for several decades. Fittingly, Arun Jaitley’s speech dwelt on that intellectual and administrative continuity across time and political divides that made the GST possible – from Raja Chelliah’s early identification of the role of the value-added tax to V P Singh’s MODVAT initiative to the Empowered Committee process that led to implementation of the state VATs to Vijay Kelkar’s Finance Commission advocacy of a single-rate GST and, of course, the many contributions of the National Institute of Public Finance and Policy (NIPFP).  

Then the rubber hit the road and lofty rhetoric had to contend with mundane, pesky reality. The GST was jinxed in the timing of its birth. The GST was always going to affect, albeit temporarily, small businesses and the informal sector because formalisation was one of the GST’s rationales. But since it followed soon after demonetisation which imposed costs on the same constituency, GST’s reception and implementation were doubly marred. Demonetisation was the extra cross that the GST had to bear.

Timing apart, what did we get right and wrong on the GST?

First, and foremost, strong conviction about the virtue of simplicity was missing at the highest political levels. The committee that I headed had recommended a three-rate GST structure – low (for essentials), standard (applicable for most products) and high (for demerit and luxury goods). But achieving that simplicity while preserving revenues required raising some of the prevailing low rates which was politically anathema. Simplicity was sacrificed.

For evidence on weak convictions about simplicity, one just has to look at the schedule of cess rates which have little to do with protecting the poor. It is shuddering in its complexity. The GST is still paying the price for central and state governments talking the talk of the Good and Simple Tax on July 1, 2017, but not walking the walk thereafter.

Second, compensation played out exactly as was anticipated. On the one hand, it did reassure states, justifiably anxious about revenues in a new and untried system. On the other hand, it also created moral hazard, and exactly as feared. The Centre in 2019 went on a populist rate-cutting binge but with the full connivance of the states whose incentives to resist were blunted by the insurance of compensation. In some ways, compensation was both necessary and the subsequent moral hazard it created unavoidable. That tension was unavoidable.

Third, one aspect of my committee’s recommendations turned out to be right but for the wrong and unanticipated reason. I did not want a compensation cess and considered that compensation should come out of the central government’s coffers. In contrast, the Department of Revenue thought that to preserve the incentives against rate-cutting, states should have skin in the game — if compensation became necessary then collective action of increasing rates within the GST Council with all the associated burden-sharing was the way to go. At the time, this seemed a reasonable design principle.

But no one had anticipated the Covid shock, a truly black-swan event. And that highlighted a deep flaw in the design of India’s federal finances which successive Finance Commissions have not really grappled with. When there is a national shock, the Centre has greater ability to respond than the states which are limited by fiscal rules, caps on borrowing and imperfect credibility. Insurance against large and common shocks must be provided by the Centre. My proposal would have forced that. The compensation cess arrangements muddied burden-sharing, engendering recrimination. But neither the supporters of the cess should be blamed nor should those of us who were against it deserve any credit. Contingencies of the Covid sort were simply beyond the scope of our thinking then.

Fourth, the governance structure of the GST should have been modelled much more along the lines of the Empowered Committee with equal convening and chairing roles for the states as well as the Centre. This was a mistake which partly came about because Arun Jaitley’s democratic and inclusive conduct of the GST (with exceptions) in the early period lulled us into complacency. Not everyone anticipated how centralising the government would become more broadly which vitiated the trust between the Centre and states.

That is the elephant in the room which illustrates a simple truth about GST design – if that broader trust exists, formal design rules are moot or surmountable but if that trust is missing, no design, however well-crafted, can help. A politically powerful Centre willing to assert its power will just get its way. There is no getting around that.

Finally, on compensation. Despite the problems it was bound to create, compensation was the right way forward to secure consensus on the GST. And limiting it in time was a reasonable compromise between the two objectives – insurance against revenue loss but minimising the resulting moral hazard problem.

I felt that time limits on compensation were the right way to go for another reason. I was optimistic that revenues would become buoyant enough for compensation to fade in its salience.  Post-Covid, that has happened, as Josh Felman and I showed in a recent column: the GST/GDP ratio is now higher than the pre-GST level of comparable taxes. But history has intervened. The trust issue now hangs like a cloud over compensation despite revenue buoyancy.

 

Many good recommendations have been made for improving the GST. I could add to them but I cannot muster the confidence that the objective circumstances are propitious for constructive discourse and for reversing some of the damage done. For example, the messy cess must be eliminated; instead, it has been extended until 2026. But in discussing what still constitutes an amazing achievement of Indian democratic politics, it seems ungenerous to end on too negative a note.  

When the Constitutional Amendment Bill was being voted on in Parliament in August 2016, there were in fact multiple votes for each of the specific provisions with the screen flashing the count after each of them. To the surprise of many of us sitting there, the vote count fluctuated, never in the negative column, but wildly in the positive column, from 385-0 to 415-0 to 400-0. Arun Jaitley quickly spotted the problem. Tired, irritated and amused in equal measure, he turned around to his back-benchers and muttered: bevakoofon ko button bhi dabana nahi aata hai (“the fools don’t even know how to press a button”).

Politicians’ button-pressing skills are the least of the problems today as the country seeks to make the GST a genuinely Good and Simple Tax.

The writer is former chief economic advisor and chairman of the committee on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax that submitted its report in December 2015.