View: Comprehensive reform of GST structure preferable to repeated small changes


Taxation, at its very essence, is as much a political issue as it is an economic one. Unfortunately, the economic aspect is often misunderstood, leading to a complicated taxation structure every few decades.

The goods and services tax (GST) could bring an end to this and the GST Council will be wise to shed their obsession with revenue-positive changes by hiking rates. A prudent approach would be to prioritise efficiency of the taxation structure and create a conducive environment for higher economic growth.

The apex decision-making body as far as GST is concerned is the GST Council and not the Union government. Any credit must be attributed to the council, just as it must be held responsible for any errors.

Over the course of last two years, we went back at the
GST reform and looked at close to 1,900 line items that are used to classify most of economic goods and services that are under GST’s purview. The exercise included classification of items as consumption goods, intermediate goods, etc, apart from classification across various sectors. The exercise was done with a view to understand how to simplify GST. A simpler GST would not just be more efficient but would also benefit MSMEs, thereby leading to several efficiency gains for the government while also improving revenues.

Unfortunately, the discussion on the GST and its subsequent reforms have focused on higher rates to generate greater revenues. The obsession with increasing rates to improve revenues has been well engrained over the years even as many have ignored the non-linear relationship that tax rates share with revenues.

Repeated changes create greater uncertainty and higher costs for MSMEs. A complete and comprehensive reform of the structure of the GST is preferable to repeated small changes. An ideal taxation system is one that is efficient – that is, one that can generate greatest amount of revenues with least possible costs or economic distortions. This should be the guiding principle of designing a taxation structure rather than redistributive concerns, which should be left for the fiscal expenditures.

Therefore, in an ideal world, we should have an efficient taxation system with fiscal expenditures as the de-facto tool for redistribution, rather than having high taxes on some items presumably consumed by the rich. This is more important for a developing country as the consumption basket of the population shifts drastically as the economy grows. For instance, soft drinks, which were considered luxury items 30-40 years ago, have long since become everyday items. Similarly, television was considered luxury items 20-30 years ago, are found in every slum house. In a hot country like India, coolers and air-conditioners are rapidly becoming a necessity for the lower-middle class. Therefore, there is no rationale today for higher taxes on them when compared to other consumption articles.

Our proposed reform consists of an efficient GST with a uniform 15% rate on roughly 75% of items, while exemptions should be given to basic food, medicines, health services and education. This means cutting down the overall list of exemptions with the objective of reducing distortionary impact that such exemptions have on the taxation structure. The higher rates of 30% or so, inclusive of cess, should be levied on cigarettes and betel nuts, which have severely negative health effects, and goods with high-income elasticity like cars, which raise the buoyancy of taxes and help the reformed system remain neutral. Such a simplification will help reduce costs for MSMEs, who seemed to have suffered disproportionately from the pandemic.

The reform proposed here may not necessarily be revenue-positive, but would lead to an efficient taxation system. In fact, the obsession with increasing revenues by hiking rates ignores taxation economics as it ignores the distortionary impact of high taxes on consumption choices. Moreover, there is a case for a revenue-negative reform, rather than a positive one given that private consumption remains below pre-pandemic trends and consumer confidence has collapsed. Hiking rates will subject the economy to yet another adjustment process that may dampen recovery prospects.

Buoyant tax revenues are a signal that tax compliance has picked up over the last few years as the GST system has stabilised and some of this could also be an outcome of formalisation because of the new taxation system. Therefore, the justification for a short-term, revenue-positive reform has weakened. Ideally, what is desired is to incentivise greater formalisation and reward it, rather than penalise it by hiking taxes.

Virmani is former chief economic adviser, GoI, and Bhasin is a New-York based economist

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