After Yes vote, government stares at GST rate challenge

Now that the major hurdle of Rajya Sabha has been crossed with the passage of the Constitution (122nd Amendment) Bill for the crucial goods and services tax (GST), the government is staring at another big challenge – working out a tax structure that does not stoke inflation or widens its fiscal deficit.

GST will unify all indirect taxes such excise, value added tax (VAT), entry tax, luxury tax and others to create a borderless single market.

On Thursday, Union Finance Minister Arun Jaitley said the government should look at an "optimum rate" of standard GST, which would apply to 60-70% of the goods that would come under it.

He did not specify any rate but hinted that it could be higher than the 17-19% recommended by his chief economic advisor (CEA) Arvind Subramanian in December last year.

"What you need is an optimum rate. Currently, what the tax payers are paying is phenomenally high. For almost 60-70% of commodity, on a weighted average, he is paying 27% plus a large number of small taxes that makes it 30-32%. The guiding principle laid by the empowered committee (of state finance ministers) is that this rate has to come down. It will gradually slide down. This will have to be married with their (state FMs) second intent that states need enough money for their own developmental activities. A balance between the two will always have to be maintained by GST Council (to be set up to come up with recommendations for the GST Law)," he said.

In the Constitution Amendment Bill, the government has committed to fully compensate revenues losses of states for the first five years. It is feared that if the GST rate is fixed low then state governments would lose more revenue and the Centre may be forced to pay them from its kitty. This could disturb its fiscal deficit target.

However, many tax experts believe that if the government decides to go for a higher than 18% rate it may prove counterproductive and may defeat the purposes that the GST has been conceived for – better compliance, improved revenue collection and boost to the economic growth.

MS Mani, senior director for indirect taxes of Deloitte India, said if the standard GST rate is very inflationary it may lead to slowdown in economic growth and lower the compliance rate.

"If it becomes very inflationary then effectively it will reduce consumer spending. And if it reduces consumer spending, then production of goods and services will go down, and if that goes down then it would start affecting the GDP growth rate," he said.

Jaitley has said that GST will add two percentage points to the GDP.

Mani suggests different GST rates for goods and services for three years looking at its impact on both.

"The challenge in (GST) rate is coming up because we are trying to get one-size-fits-all for goods and services," he said.

Today, the excise and VAT on goods comes to around 26-27% and so if the GST rate comes at 18%, it will be a bonanza for manufacturers. On the other hand, for service providers, who currently pays 15% tax, 18% GST rate would have an adverse impact.

"Why can't we have two different rates for manufacturers of goods and service providers for the first three years? In respect of goods, for the first three the Council can recommend a rate 20% for the first year, 19% for second and 18% for the third year. For services, it could be other way round – 16% for the first year, 17% for second and 18% for the third year. So, in the third year, the two rates will converge and from that year onwards it should be same for the rest of its life," suggested Mani.

Pratik Jain, partner and leader, indirect tax, PwC India said the government should follow the principle of "low tax rate high tax base" while fixing the standard GST rates. He believes that a low rate of the proposed unified indirect tax will spur economic growth and shrink the parallel economy even while improving the compliance.

"The government should start with 18% or even lower rate and then see how it goes. It should focus on tax administration and plugging the leakages. It should also try keep the concession and exemption to the lowest possible to arrive at a lower GST rate," he said.

DS Rawat, secretary general, Assocham, said the government should not try to meet compensation obligation to states by increasing the tax burden on the people. He also wants a rate around 18%.