Goods and Services Tax: How neutral is the revenue neutral rate ?

Dated 23rd December, 2014

The recommendation for an integrated goods and services tax (GST) in India may be traced back to the report of the Kelkar task force on the implementation of the Fiscal Responsibility and Budget Management Act, 2003, published in July 2004.

The original proposition for an integrated GST was with the primary objective of controlling the budget deficit. It has since expanded to take within its fold the need to expand the tax base and also address the shortcomings of the existing indirect tax machinery, particularly eliminating the multiplicity and cascading effect of taxes.

The first official proposal manifested by the Union finance minister in the budget speech of FY 2006-07 aimed at the introduction of GST by April 1, 2010, which was subsequently deferred to April 1, 2013.

The trust deficit between the Centre and the states, coupled with constitutional restrictions, could be blamed for the delay. With the trust deficit bridged after continuous dialogue between the Centre and the states, not to mention a promise for compensation, and the Constitution Amendment Bill introduced in Parliament, it is the determination of a revenue neutral rate (RNR) that has aroused considerable debate.

RNR, in layman terms, is the rate that allows the Centre and states to sustain the current revenues from tax collections and, therefore, takes within its ambit, amongst others, any tax losses because of taxes subsumed and/or phased out, grant of input tax credits as well as sharing of the tax base, i.e. taxation of goods and services.

The first official recommendation by the Thirteenth Finance Commission Report of the Task Force on Goods and Services Tax proposed taxation of all goods and services at a single GST rate of 12% comprising of 5% for Central GST (CGST) and 7% for State GST (SGST).

Recently, the National Institute of Public Finance and Policy (NIPFP) in its report on Revenue Implications of GST and Estimation of Revenue Neutral Rate: A State wise Analysis determined, under various scenarios, RNR up to 27.54% comprising of CGST of 12.77% and SGST of 14.77%.

The recommendation of the NIPFP analysis seems to have caused a stir, and the support it is rumored to have garnered from the sub-committee constituted by the Empowered Committee of State Finance Ministers is a cause for concern.

To begin with, the rate recommended by the NIPFP is close to 150% higher than the rates historically discussed while contemplating the introduction of GST, and much higher than that recommended by the Thirteenth Finance Commission.

One may question some assumptions relied upon while deriving the rate. For instance, levy of Central Sales Tax at 4% instead of the current concessional rate of 2%, fate of Entry Tax and Octroi, etc. The prospect of broad-basing GST by covering petroleum products, real estate, alcohol, electricity, etc, also ought to be seriously considered so as to reduce the RNR to a realistic level.

Trends suggest that many economies while transitioning to GST have embraced a modest rate, often single digits. For instance, Singapore introduced GST on April 1, 1994, at 3% which has gradually progressed to the current rate of 7%. Malaysia, currently contemplating introduction of GST effective April 1, 2015, is considering a rate of 6%.

The rates recommended by the NIPFP, even if theoretically justifiable, may not be encouraging for trade and industry which is just about reeling from the unpreparedness for the introduction of GST, potentially as early as April 1, 2016.

Even from an international perspective, this rate appears to be a misfit. According to the KPMG International Cooperative’s Corporate and Indirect Tax Rate Survey, 2014, from a considered view of 132 countries across the globe, the highest rate of GST currently prevalent is at 27% in Hungary, the lowest being that in Aruba of 1.5%. The survey also reveals that the 10 highest tax rates range from 27% to 18%. Adopting a rate of 27% is evidently unlikely to put India on a pedestal in the global scenario.

Not to mention, in a developing nation such as India, there are several other socio-economic factors which also ought to be taken into consideration while determining the RNR. For instance, introduction of such an exorbitant rate would certainly have to be in oblivion of the inflation which India, after great struggle, is just about emerging from. To a nation generally averse to paying taxes, pegging the rate as high as 27% could encourage evasion and non-compliance, which could defeat the very purpose of the introduction of GST.

Just when GST was beginning to seem like a mirage, the newly elected government has certainly rekindled some hope. Whether the hope is short-lived or a promise for ‘happily ever after’ is something only time can tell.

This article is published in Financial Express on 23rd Dec, 2014)