The Supreme Court of India has recently pronounced that recommendations of the Goods and Services Tax (GST) Council are not binding on the Union or State governments. One way this pronouncement has clarified is that both the Union and State governments enjoy fiscal autonomy, as their freedom to set tax rate under GST depending on revenue needs will continue. On the other hand, the pronouncement has created apprehensions among stakeholders that probably harmonized rate structure of GST may be at stake in future. The pronouncement came at a very crucial juncture when the GST Compensation regime will be ending on 30 June 2022 and a Group of Ministers is working on the restructuring of the GST rates. Even after five years of introduction, Indian GST is evolving in many ways and stabilization of the GST system will be delayed if either the Union or State governments decide to discontinue the harmonized rate structure.
It is believed that the scope of deviation from the harmonized GST structure will be limited to the GST rate structure; as other components of the harmonized GST system (e.g., Acts, Rules, Regulations, Processes, Procedures, Tax Administration) will be the same across all tax jurisdictions. In other words, probably neither States nor the Union government may deviate from the harmonized structure of GST, except in setting GST rates. On average two-third of own tax revenue of State governments have been subsumed into GST. Therefore, to keep pace with rising demands for public expenditures, States may feel the urge to increase GST rates to mobilize larger public resources. However, it is to be noted that tax collection also depends on the tax base, tax compliance, tax efforts (or efficiency) etc. apart from tax rates.
Therefore, enlarging the tax base by protecting the consumption base of a State (i.e., aggregate consumption expenditures of a State) would be important. For example, States could rein in base erosion due to tax-shopping (or cross-state purchases) due to the availability of better options/ choices in neighbouring states by facilitating investment in consumer retail infrastructure. Similarly, demands for goods and services may be enlarged by providing economic opportunities to a larger group of people by investing public infrastructure. Improving tax compliance, especially by pursing taxpayers to file both the GST monthly returns – GSTR-1 (invoice-wise details of outward supplies) and GSTR-3B (summary of inward and outward supplies, availability of input tax credits and tax liabilities thereof) could also help the states to improve tax collection. Effective utilization of analytical tools developed by the Business Intelligence and Fraud Analytics (BIFA) unit of the GSTN depends on State-specific compliance in filing both GSTR-1 & GSTR-3B returns. A large section of taxpayers (who are either not filing any tax returns or filing any one of the mandatory tax returns, either GSTR-1 or GSTR-3B) remain outside the purview of tax administrations for the purpose of tax enforcement.
Tax compliance is also a function of tax effort, therefore investing in tax administration infrastructure, especially in data analytics, fraud investigations, monitoring of inbound and outbound flows of goods may help in augmenting revenue mobilization. Therefore, deviating from harmonized GST rate structure may not be required if other factors of tax collection are strengthened. Moreover, changing tax rates destabilize the tax system and enhances the possibility of revenue leakage.
There are benefits as well as costs associated with harmonized GST rate structure. The benefits are accrued in terms of ease-of-tax administration and ease-of- tax compliance (and associated compliance costs). In the GST regime, adjustments of input tax credits (ITC) are not restricted to intra-state supplies alone, as was the case in the State Value Added Tax (VAT) regime. For effective monitoring of revenue, tax officials need to assess transaction chains which involve multiple layers of inter-state transactions. Therefore, harmonized GST rate structure lessens the tax administration burden in matching the inward and outward invoices.
In absence of robust IT system for backend processing of tax information (administrative data) and without access to information of taxpayers of other States to tax officials across field formations, if there are differences in law, practice or rates, it would be impossible to catch the tax evaders. In other words, without access to cross-state information to all levels of tax officials, any attempt to deviate from harmonized GST rate structure may result in increasing burden on tax administration and increase the possibility of revenue leakages. Similarly, tax payers operating in multiple States, tax compliance costs will increase if harmonized GST structure is not maintained. Building a robust IT infrastructure (for front- and back-end processing of tax information) to handle rate differentiations across tax jurisdictions with automated invoice-matching system may help to accommodate in future any move to deviate from the harmonized GST structure.
Since a Group of Ministers is working on restructuring of GST rates, it will important to reduce number of GST rates gradually to two to three rates. This will also contain revenue leakages on account of misclassification, improve tax compliance and reduce tax administration burden. Though comprehensive assessment of tax expenditures is yet to be taken up for the GST regime, protecting the tax base by containing tax expenditures on account of tax exemptions, incentives, thresholds, abatements etc. may help to protect the tax base.
The ongoing GST compensation period will be ending on 30 June 2022 and States will receive arrears of GST compensation corresponding to GST transition period (i.e., 1 July 2017 to 30 June 2022). Probably designing a framework to compensate States for GST revenue shortfall may help to dissuade them to deviate from harmonized structure of GST in post-GST compensation period. It will be imperative for States to keep the harmonized structure of GST intact, as it will reduce revenue leakage on account of trade diversions and misclassifications of goods. There is also apprehension that rate differences among States may lead to Input Tax Credit conflicts.
If the deviation from the harmonized GST rate structure becomes unavoidable, it will be important to set a common harmonized floor rate with a band which will allow States some flexibility in fixing rates. The Rajya Sabha Select Committee suggested that GST rates will be levied with floor rates and with bands, where a band is defined as “Range of GST rates over the floor rate within which Central Goods and Service Tax (CGST) or State Goods and Services Tax (SGST) may be levied on any specified goods or services or any specified class of goods or services by the Central or a particular State Government as the case may be”. There were also discussions that maximum 1 to 2 per cent deviation from the floor rate should be allowed. This option may be explored as a last option if States are keen to set their own GST rates by deviating from the harmonized GST structure.
There is always a trade off between harmonization of tax system and fiscal autonomy of States. Given the federal structure of India, it is desirable that tax rates will remain harmonized across States to minimize the compliance burden as well as cost of tax administration. Harmonization of tax rates across States is expected to minimize rate wars across States and rein in revenue leakage due to cross border tax shopping, trade diversions, and misclassification of goods.
(Dr Sacchidananda Mukherjee is an Associate Professor at the National Institute of Public Finance and Policy (NIPFP). Before joining NIPFP, he was with International Water Management Institute (IWMI), Hyderabad and World Wide Fund for Nature (WWF)-India, New Delhi.)