Goods and Services Tax (GST) was introduced in India in July 2017 to improve both production and consumption efficiency. The pre-GST system of domestic indirect taxes was characterised by multiplicity of taxes, multiplicity of rates for the same tax, cascading of taxes, undue emphasis on the origin principle of taxation, and fragmentation of a genuine all-India common market.
However, GST 1.0 was only partial. Some important goods were left out of its purview, including alcoholic products for human consumption, electricity, and petroleum products. It continued to have multiple rates, which also kept on changing through various GST Council meetings. A compensation cess, now discontinued, was introduced to facilitate the transition.
India’s GST is still an incomplete story. A large share of sales pertaining to petroleum products, agricultural products, electricity, and real estate remains outside the purview of GST. In terms of revenue importance, the share of taxation of petroleum products and alcoholic beverages by central and state governments amounted to 60.8% of GST revenues, excluding compensation cess, in FY20. In FY24, this share was 50.8%. If we look at the share of value-added tax (VAT) on petroleum products and state excise duties in State GST (SGST) revenues, it amounted to 67.9% in FY24.
The main roadblock to further reforms in the GST structure arises due to the apprehension of both central and state governments that they would lose revenue autonomy, given the relative importance of revenues from taxation of petroleum products and alcoholic beverages.
To ensure revenue autonomy to central and state governments, petroleum products and alcoholic beverages can be included in the GST framework by subjecting these goods to a non-rebatable levy. In the case of central GST (CGST), this could be an excise tax, and in case of states, this could be VAT or sales tax. Both of these should be made non-rebatable. This would amount to integrating environmental and demerit taxes in GST through the mechanism of a non-rebatable excise and/or cess on polluting and demerit inputs and outputs.
Further, the GST rate structure needs to be streamlined. We can have at best two to three rates. This structure may consist of a core rate, a concessional rate for goods of mass consumption, and a demerit rate for polluting and other demerit, including luxury, goods.
Another issue with GST 1.0 relates to high compliance costs because of excessive formalities accompanied by continued tax evasion. There is a need to further simplify compliance formalities of GST.
This reform can not only serve the purpose of restoring revenue buoyancy but also protect the revenue autonomy of central and individual state governments. The GST core rate may be fixed at a suitable level, but it is the non-rebatable levy that can be used to calibrate with upward and downward adjustments. Both the Centre and states may be given flexibility in determining the applicable rate of levy in their respective jurisdictions.
The GST Council may have to play a critical role in continuing with GST reforms so that it is transformed into a truly comprehensive value-added tax system.
GST 2.0 should be designed to ensure comprehensive coverage of all goods and services, a reduced number of tax rates, and reduced compliance costs by further simplifying compliance formalities. The Goods and Services Tax Network has access to a comprehensive dataset, which should be streamlined and shared with all state governments and other stakeholders so that inter-state trade and import data can be studied for further optimising India’s growth rate.
Future GST reforms should include:
(1) further rationalisation of GST rates, reducing to at best, a two or three rate structure.
(2) Bringing into its ambit demerit and polluting goods with the provision of a non-rebatable levy to make up for the consequent revenue loss and provide appropriate signals for demerit and polluting goods.
(3) Further strengthening of the IT platform and reduction in compliance requirements.
(4) Strengthening GST data and sharing it with not only central and state governments but also with other stakeholders.
A domestic indirect tax system that promotes a genuine all-India market, promotes production and consumption efficiency, and minimises compliance costs is critical for India to achieve its Viksit Bharat ambitions.
Views are personal. The author is a Chief Policy Adviso at EY India
