A grand tax bargain in danger of coming apart

Context: A Goods and Services Tax version 2.0 may have to be designed soon, given the flaws in existing structure.

Flaws in existing GST structure

• Political architecture is asymmetrically loaded in favour of the Centre:
  • Biased voting system: Central government has one-third vote, and States have two-thirds of total votes with equal voting rights regardless of size and stake. 
    • Thus, with the support of a dozen small States whose total GST collection is not more than 5% of the total, the system is hugely in the Centre’s favour.
  • No particular body is tasked to adjudicate federal tensions: Federal tensions are bound to rise as the compensation scheme guaranteeing 14% growth in tax collection is going to end in 2022.
    • Since median tax buoyancy still remains below unity, continuing the scheme is challenging.
• Design flaws in tax structure: The net loss due to design flaws could be as high as one third.
  • Exemptions: 45% to 50% of commodity value is outside the purview of GST, such as petrol and petroleum products. Most trading and retail establishments (however small) are out of the fold of GST.
    • In 2017, cess and surcharge formed 56% and 35% of excise duty on petrol and diesel. Now, their share has increased to 91% and 85%.
  • Trade issues: States which export or have inter-State transfers or mineral and fossil fuel extractions are not getting the revenue as the origin States.
  • Frequent tweaking: Pre-existing threshold level of VAT has been tweaked too often, which has led to evaporation of tax base incentivising, enabling evasion and misreporting.
  • Increased prices for consumers: At the retail level, irrespective of whether Input Tax Credit (ITC) is required or not, the burden can be passed off to the consumer.
• Erosion in tax base: Provision of exemptions from registration and taxation of GST lead to increase in evasion or misclassification and reduction in tax realisation.
• Infrastructure and technical issues: Compliance with GST return (GSTR-1) filing stipulation and resultant tax information is not up to date.
  • Fraudulent claims of Input Tax Credit (ITC) because of a lack of timely reconciliation are quite high though it has come down by two thirds.
  • Tax evasion, estimated by a National Institute of Public Finance and Policy’s paper, is at least 5% in minor States and plus 3% in major States.

Conclusion: Given all these problems, a version 2.0 of GST may have to be designed sooner rather than later.