Why It’s the Right Time to Reform GST

Context: Now that tax collections have turned the corner, rationalizing the structure will accelerate the recovery process.

Silver linings to Goods and Services Tax (GST) collections:

• Rise in collection: The GST collections reached ?1.05 trillion, an increase of 10% on a year-on-year basis.
• Among the large states, Andhra Pradesh, Chhattisgarh, Jharkhand and Odisha
• showed increases of more than 20%
• Spirit of conciliation between the Centre and the states: in the decision by the former to borrow and compensate the states for the loss of revenue provides some comfort.
• Technology Factor: 
• Introduction of e-invoice system (for taxpayers having turnover over Rs 500 crore) has increased the GST collections. This is because :
• While there are only 48,000 taxpayers in such a category, their contribution to tax is estimated at more than 45%.
• For, E.g. The ratio of tax paid to turnover for large taxpayers works out to 0.48% as compared to the average for the Karnataka stands at 2.36%.
• Introduction of Tax Information Network (2004): resulted in the sharp increase in the ratio of Centre's direct tax revenue to GDP from 3.9% in 2003-04 to 6.4% in 2007-08,

Way Forward:

• Better Compliance through e-invoicing: To plug the gaps (misuse of tax credits and fake invoicing) GST Council is well advised to expand the coverage under e-invoicing.

• Broadening Base: GST Council should immediately prune the exemption list and introduce the reverse-charge mechanism to broaden the base.

• Rationalization of the structure of the tax: in order to -

• Avoid inverted duty structure: where tax rates on inputs are higher than those on outputs: for e.g. in Electrical transformers, railway wagons, textile products, plastic bags and solar modules 
• Have a relook at exemption list: Comprehensively cover legal services in the tax net and ensure better compliance of the tax by professionals like doctors, architects, and contractors.

• At present, as many as 148 items under four-digit HSN classification (having almost 50% weight in the consumer price index) have been kept in the exempted list.

• Expand coverage: by introducing a reverse charge mechanism where the receiver is liable to pay the tax, not the supplier.

• Include petroleum and electricity in the tax net: Taxes on consumption and sale of electricity is specifically assigned to states in the Seventh Schedule (entry 53).
• Have a separate excise on these items: to ensure justifiable distribution of taxes between the Centre and the states.

• Reduce the number of tax rates: leading to lower classification problems, minimizing inverted duty structure and reducing costs by making the tax system simpler.

• Over 81% of countries that introduced GST since 1999 have opted to levy the tax at a single rate.
• It is desirable to reduce the number of tax rates into three; a general rate, a rate for "sin" goods, and a merit rate.
• Prune the list of "sin" goods which are taxed at 28% and additional cess on the building materials and passenger automobiles.

Conclusion: Low threshold, excessive exemptions and multiple rates get into the tax structure for successful adoption of the reform, but it may prove to be extremely difficult to remove them. The best time to undertake reforms is now.