Ishan Bakshi
In theory, the shift to GST made eminent sense. It would bring about uniformity in tax rates across the country, integrate the country into a common market, end the cascading of taxes, widen the tax base, and raise government revenues. Yet, in practice, some of these expectations have been belied. While the tax base has widened, revenues have fallen well short of expectations. The compliance burden has risen, and a fake invoice industry has mushroomed. At the current juncture, with sluggish growth, and with various stakeholders looking to extract further concessions, it is difficult to see how this system can be turned around to deliver its original promise.
Why have GST collections not measured up to expectations? The first possible explanation is that during the shift to GST, several entities simply opted out of the system. But this explanation does not hold up to scrutiny. The total number of taxpayers in the pre-GST regime were around 93 lakh (63 lakh VAT dealers, 26 lakh service taxpayers, and 4 lakh central excise payers). Of these, 54 lakh (36 lakh VAT dealers, 17 lakh service taxpayers, and 1 lakh central excise payers) were automatically excluded from its ambit as they fell below the initial threshold limit of Rs 20 lakh. At the end of February 2019, total registrations stood at 1.2 crores. Of these, 59.74 lakh had migrated from the pre-GST regime, while the rest were new registrations. This implies a significant expansion in the tax base on two counts: First, even those excluded from GST opted to stay inside the system, and second, there has been a significant increase in new registrations.
But even with this expansion, collections have not matched budgeted expectations. This could be due to a combination of three factors: First, the tax rates under GST are lower than in the earlier regime — GST was not revenue neutral to begin with. Second, there has been massive tax evasion due to under-reporting, input credit scams and fake invoices. And third, a slowing economy has impacted firm revenues, and thus tax collections.
Theoretically, GST should have been revenue-neutral. The fitment exercise should have been undertaken in a manner so as to ensure that collections pre and post GST are the same, not taking into account efficiency gains. But, in the course of the GST Council’s deliberations, it seems that this fundamental principle was not adhered to, and other considerations dominated.
The council began its deliberations not with the single objective of revenue neutrality, but with multiple objectives in mind. It wanted to ensure that rates were close to the existing tax incidence (accounting for cascading); to ensure minimal impact on inflation; that the proposed rate structure was not regressive in nature and that items of mass consumption were not taxed at a higher rate. Achieving all these objectives simultaneously is a difficult task.
When the committee of officers undertook the exercise of fitting the slab rates of 12 and 18 per cent, it was asked to take into account the “current economic and social realities”, not revenue neutrality. Further, some goods, which were earlier considered as luxuries and attracted higher rates, were moved to lower tax slabs as they were “used by all segments of society”. Consideration was also paid to the “optical perception of GST”. There was great emphasis on ensuring minimal impact on inflation, notwithstanding that inflation should be looked at the net of taxes.
This shift away from the principle of revenue neutrality, which created space for lobbying for lower taxes and various exemptions, suggests that the GST structure may not have been revenue-neutral, to begin with, in which case, expecting high revenue buoyancy from the beginning was unrealistic. And this was before the rate cuts in 2018. A widened tax base should have offset the impact of lower tax rates, but that has not been the case.
Then there is the issue of tax evasion. While it is difficult to arrive at firm estimates of the scale of the problem, there are some indications of its size. In May 2018, it was estimated that the value of goods (July 2017 to March 2018) entering a state appeared to be under-reported by around Rs 50,000 crore in the case of West Bengal, Rs 60,000 crore in Madhya Pradesh, and Rs 1,50,000 crore in Maharashtra. Numerous cases of tax fraud and fake invoice scams have also been detected since then. These are large amounts, and though they are likely to be an underestimation, they nonetheless point to significant leakages. Measures such as the e-way bill could have helped plug some of the gaps, but it is difficult to know for sure.
Many have argued that invoice matching will help. Perhaps implementing it from the beginning — it was estimated that 91 per cent of the tax payers had fewer than 50 invoices to accept — could have helped plug the loopholes. But it is debatable whether invoice matching can end under-reporting (read collusion) and fake invoices. There is also the issue of state capacity. As the Central and state administrations can intervene in only about 3 lakh cases in a year, their capacity to track lakhs of transactions on a daily basis is questionable. These structural issues have been compounded by a slowing economy. Growth of GST collections has slowed since Q4FY19, in line with the fall in corporate tax collections, indicating the impact of sluggish economic growth.
There are two options now: Either recalibrate expectations or plough ahead. The latter requires tough decisions. To begin with, firms that registered when KYC regulations were relaxed need to be scrutinised. This will help eliminate “laptop shops”. Second, lower the cutoff for the composition scheme. A higher level simply encourages business “splitting” as was the case previously. Third, reduce exemptions. Fourth, while this may not be an opportune moment, at some point, the council must deliberate on the rate structure, bringing it in line with pre-GST levels.
This article first appeared in the print edition of The Indian Express, titled ‘There’s a hole in the GST’, on January 15, 2020.
In theory, the shift to GST made eminent sense. It would bring about uniformity in tax rates across the country, integrate the country into a common market, end the cascading of taxes, widen the tax base, and raise government revenues. Yet, in practice, some of these expectations have been belied. While the tax base has widened, revenues have fallen well short of expectations. The compliance burden has risen, and a fake invoice industry has mushroomed. At the current juncture, with sluggish growth, and with various stakeholders looking to extract further concessions, it is difficult to see how this system can be turned around to deliver its original promise.
Why have GST collections not measured up to expectations? The first possible explanation is that during the shift to GST, several entities simply opted out of the system. But this explanation does not hold up to scrutiny. The total number of taxpayers in the pre-GST regime were around 93 lakh (63 lakh VAT dealers, 26 lakh service taxpayers, and 4 lakh central excise payers). Of these, 54 lakh (36 lakh VAT dealers, 17 lakh service taxpayers, and 1 lakh central excise payers) were automatically excluded from its ambit as they fell below the initial threshold limit of Rs 20 lakh. At the end of February 2019, total registrations stood at 1.2 crores. Of these, 59.74 lakh had migrated from the pre-GST regime, while the rest were new registrations. This implies a significant expansion in the tax base on two counts: First, even those excluded from GST opted to stay inside the system, and second, there has been a significant increase in new registrations.
But even with this expansion, collections have not matched budgeted expectations. This could be due to a combination of three factors: First, the tax rates under GST are lower than in the earlier regime — GST was not revenue neutral to begin with. Second, there has been massive tax evasion due to under-reporting, input credit scams and fake invoices. And third, a slowing economy has impacted firm revenues, and thus tax collections. Theoretically, GST should have been revenue-neutral. The fitment exercise should have been undertaken in a manner so as to ensure that collections pre and post GST are the same, not taking into account efficiency gains. But, in the course of the GST Council’s deliberations, it seems that this fundamental principle was not adhered to, and other considerations dominated.
The council began its deliberations not with the single objective of revenue neutrality, but with multiple objectives in mind. It wanted to ensure that rates were close to the existing tax incidence (accounting for cascading); to ensure minimal impact on inflation; that the proposed rate structure was not regressive in nature and that items of mass consumption were not taxed at a higher rate. Achieving all these objectives simultaneously is a difficult task.
When the committee of officers undertook the exercise of fitting the slab rates of 12 and 18 per cent, it was asked to take into account the “current economic and social realities”, not revenue neutrality. Further, some goods, which were earlier considered as luxuries and attracted higher rates, were moved to lower tax slabs as they were “used by all segments of society”. Consideration was also paid to the “optical perception of GST”. There was great emphasis on ensuring minimal impact on inflation, notwithstanding that inflation should be looked at the net of taxes.
This shift away from the principle of revenue neutrality, which created space for lobbying for lower taxes and various exemptions, suggests that the GST structure may not have been revenue-neutral, to begin with, in which case, expecting high revenue buoyancy from the beginning was unrealistic. And this was before the rate cuts in 2018. A widened tax base should have offset the impact of lower tax rates, but that has not been the case.
Then there is the issue of tax evasion. While it is difficult to arrive at firm estimates of the scale of the problem, there are some indications of its size. In May 2018, it was estimated that the value of goods (July 2017 to March 2018) entering a state appeared to be under-reported by around Rs 50,000 crore in the case of West Bengal, Rs 60,000 crore in Madhya Pradesh, and Rs 1,50,000 crore in Maharashtra. Numerous cases of tax fraud and fake invoice scams have also been detected since then. These are large amounts, and though they are likely to be an underestimation, they nonetheless point to significant leakages. Measures such as the e-way bill could have helped plug some of the gaps, but it is difficult to know for sure.
Many have argued that invoice matching will help. Perhaps implementing it from the beginning — it was estimated that 91 per cent of the tax payers had fewer than 50 invoices to accept — could have helped plug the loopholes. But it is debatable whether invoice matching can end under-reporting (read collusion) and fake invoices. There is also the issue of state capacity. As the Central and state administrations can intervene in only about 3 lakh cases in a year, their capacity to track lakhs of transactions on a daily basis is questionable. These structural issues have been compounded by a slowing economy. Growth of GST collections has slowed since Q4FY19, in line with the fall in corporate tax collections, indicating the impact of sluggish economic growth.
There are two options now: Either recalibrate expectations or plough ahead. The latter requires tough decisions. To begin with, firms that registered when KYC regulations were relaxed need to be scrutinised. This will help eliminate “laptop shops”. Second, lower the cutoff for the composition scheme. A higher level simply encourages business “splitting” as was the case previously. Third, reduce exemptions. Fourth, while this may not be an opportune moment, at some point, the council must deliberate on the rate structure, bringing it in line with pre-GST levels.
This article first appeared in the print edition of The Indian Express, titled ‘There’s a hole in the GST’, on January 15, 2020.
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