Whenever the government is criticised for the complicated multi-slab structure of the Goods and Services Tax (GST), the response has been standard – it has been done to protect the poor.
So, if Prime Minister Narendra Modi questions the logic of taxing milk and a Mercedes car at the same rate, union minister Arun Jaitley contrasts food and luxury cars and finance minister Piyush Goyal does the same for luxury watches and hawai chappals.
The crux of the argument is that having a single GST rate or even dual rates will push up prices for the lower income groups, and will lower prices for higher income groups. But will it? And to what extent?
The International Monetary Fund’s (IMF) selected issues paper on India points out that the GST structure can be simplified without pinching the poor significantly. And that the principle of progressivity – where those higher on the income ladder pay more tax than those on the lower rungs – will not be compromised. On the other hand, such a simple system will be less regressive (where the burden of the tax is more on the lower income groups than on the higher) than the current system.
Representational image. ReutersRepresentational image. Reuters
While agreeing that the current tax structure (as of January 2018) is designed to be progressive, the paper argues that it may not be making a huge difference. The effective GST rate for households in the lowest quintile, it points out, is nine percent. “This rises only gradually to 9.6 percent for the fourth quintile and 10.5 percent for the topmost quintile”.
That’s because of the embedded input taxes on exempted goods, since the manufacturers of these products cannot avail input tax credits, which results in a cascading of taxes and pushing up the final price. This, the paper finds, puts an additional 2.5 percent effective GST rate burden on the lowest quintile.
But this burden gets progressively lower on the higher income groups and is only 1.7 percent for households in the topmost income quintile. This is because (a) non-exempt items are able to claim input tax credit and (b) the share of exempt items in the basket of goods consumed by higher income groups is lower.
The paper also looks at different scenarios of the impact of single or dual rates on various income groups. It first looks at a flat 10 percent GST along with the current set of exemptions. While the direct tax incidence on the lower income groups is lower – because of the weight of exempt goods in the consumption basket of lower income groups – the indirect tax incidence (embedded input taxes that cannot be netted out) is the same 10 percent for all.
So this plays into the argument against a single rate, since the effective GST rate increases for the lower income groups and falls for the higher income groups.
The paper then looks at a dual rate regime – a nine percent standard rate and a 25 percent higher rate applied to items in the current 28 percent bracket. However, all the current exemptions are retained. In such a case the total tax incidence on the lower income groups is 9.6 percent and it rises to 10.1 percent for the higher income groups.
Going by this, the current system will look better for the political class, since the difference between overall tax incidence on the poor and rich is more – nine percent and 10.5 percent against 9.6 percent and 10.1 percent or even a flat 10 percent in a single rate case.
However, progressivity can be increased if exemptions were pared down significantly since they deny the benefit of netting out tax paid on inputs. The optics of exemptions is actually quite different from reality – it does not exempt the poor from taxes; they may end up paying more.
More importantly, it is well known that a simpler GST structure will reduce compliance and administrative costs – a point the IMF paper also makes. It admits that evidence on compliance costs under GST in India is still not available, but that anecdotal evidence from large firms shows “sizeable increases in costs”. The burden, then, is likely to be more for smaller firms.