A single tax rate, by definition, helps keep rates low
Though it is still unclear whether the government will be able to get the GST Bill passed given the deadlock in Parliament, it comes as a big relief to see the Cabinet accepting the major recommendations of the Rajya Sabha select committee. By agreeing to a 100% compensation for states for the first 5 years of implementing GST, for instance, there is absolutely no need any more for the 1% additional tax that was put—for the first 2 years—at the insistence of the producing states who feared a revenue loss when GST came in and the central sales tax was withdrawn. And in case the government still insists on keeping the 1% tax, its sting has been largely removed since the government has accepted the select committee’s suggestion that this not apply to intra-firm transfers —experts say this adds up to around three-fourths of all inter-state movement of goods.
With this, the attention now moves to the committee headed by chief economic advisor (CEA) Arvind Subramanian, on the revenue-neutral rate (RNR) at which the GST will be fixed—and once this rate is fixed, there will be a break-up of what tax rate the Centre will levy and what the states will. The Subramanian committee will also look at the 1% additional tax which the CEA has argued, in a newspaper article, is a disincentive for Make-in-India. When rumours of a 27-28% rate suggested by NIPFP first started floating, most compared this unfavourably with the 12% RNR estimated by the Vijay Kelkar-headed task force. That comparison was unfair for a variety of reasons. For one, the Kelkar task force RNR was a single rate applicable for all goods and services while the NIPFP number was based on the fact that there would be ‘merit’ and ‘non-merit’ goods. Assume goods and services worth Rs 100 are produced and a 12% tax is levied on them right now. If a new tax is to be levied to get the same Rs 12 of tax, the RNR will obviously be 12%. But if half of the goods and services are to be considered as ‘merit’ or used by the common man and therefore taxed at 6%, the RNR for the rest will be 18%—the NIPFP 28% tax was on ‘non-merit’ goods.
Also, in the case of the Kelkar task force, all goods and services were to be taxed—areas like real estate are now to be kept out. The maths is complicated since even if real estate is kept out of GST, certain taxes will be paid, such as on the cement and steel used for constructing an office building—but not including real estate in the GST does push up the RNR, whether by a half or one percentage point is a matter of the assumptions made. The most critical difference between Kelkar and NIPFP, of course, was the difference in the taxable base. While NIPFP relied on sales tax collections as well as CMIE’s Prowess (for data on services and taxes on it), the Kelkar task force used income tax data and then made certain assumptions, on purchases from the informal sector for instance. Since Subramanian will get the new RNR from NIPFP in a few weeks and has access to the income tax database—the database has, in fact, improved from the days when the Kelkar task force made its recommendations—he will have to examine, and validate, the assumptions made by both studies. Apart from the fact that a uniform rate of taxation will lower the RNR, it will also encourage greater compliance; and the lower the rate, the greater the compliance—indeed, greater compliance will help lower the RNR further.