GST Reform Needs a New Grand Bargain

Context: The Goods and Services Tax (GST )compensation issue strengthens the necessity for a new system between sovereign and sub-sovereign entities

Promises of GST

• Frictionless commerce across State borders. 

• Buoyant and leak-proof tax compliance

• Removal of inefficiencies like the cascade of “tax on tax”.
• Address the apprehension of States, of revenue loss due to the GST.

Abdication of responsibility by the Centre: Using the Force Majeure clause, responsibility of making up for the shortfall in 14% growth in GST revenues to the states, is being abdicated by the Centre due to:

• Fault with the design: Failed to learn from the successful design of harmonising Value Added Tax (VAT) rates across the nation.  VAT was the precursor to GST, and it too had an inbuilt reimbursement formula.

• Drop-in tax collection and  high expenditure needs due to Pandemic and recession

Arguments for Centre’s Responsibility: 

• Centre has multiple options to raise funds: Like the issue of a sovereign bond (in dollars or rupees) or a loan against public sector unit shares from the Reserve Bank of India.

• Centre can command lower rates of borrowing from the markets as compared to the States. 

• Debt markets and rating agencies don’t differentiate between the centre and state borrowings, in terms of public sector borrowings.

• Macroeconomic stabilisation is the Centre’s domain.

• Serious dent in the trust built up between the Centre and States.

• Constitutional Obligation of Cooperative Federalism: is in the nature of a “repeated game” bet­ ween the two entities, and every action must think of the future consequences.

• Kautilya too would have advised the sovereign against reneging on the promised bailout, as ful?lling the obligation helps build trust with sub-sovereigns.

Way Forward: Design needs a radical overhaul: The Grand Bargain 2.0

•  Widening of the tax base: 

• GST is a destination­ based consumption tax, which must include all goods and services with very few exceptions, such as food and medicine.
• That widening of the tax base itself will allow us to go back to the original recommendation of a standard rate of 12%.

• Commitment to a low and stable rate:

• For, E.g. Australia has kept its GST rate constant at 10%.  Likewise, India should go back to the original recommendation of a standard rate of 12%.
• Advantages: A low moderate single rate of 12% 

• encourages better compliance, 
• reduces the need to do arbitrary classification and discretion, 
• reduces litigation and will lead to buoyancy in the collection.

• This will avoid the bogey of a “revenue neutral rate” (RNR) which needlessly occupied the attention of lawmakers and officials. 

• Revenue autonomy to states: By allowing the States non-VATable surcharges on a small list of “sin” goods such as liquor, tobacco, polluting goods etc...

• Recognise Third-Tier Government:  Of the 12% GST, 10% should be equally shared between the States and the Centre, and 2% must be earmarked exclusively for the urban and rural local bodies.

• These local bodies face increased responsibility of providing government services, especially in view of increased urbanisation and decentralisation.

• Overhaul of the interstate GST and the administration of the e-way bill-

• “National Agenda for 2019 – A proposal for the GST reform” by Dr. V. Bhaskar and Dr. Vijay Kelkar describes simplified mechanism to:

• • • Reduce costs and transactions
    • Increase zero-rate exports

• The current design and implementation have failed to deliver on the promise cooperative federalism and ensuring future economic growth.
• Thus we need a Grand Bargain 2.0 between the sovereign and the sub-sovereign entities.