A Simpler, More Stable Way To Set And Reset The GST Rate

The wheels of government have really begun turning fast on implementing GST after both the Houses passed the Constitutional Amendment Bill. An aggressive roadmap has been drawn up, targeting a roll-out by April 2017. Irrespective, what is really reassuring is that the government seems to be extremely serious in making a success of this all-important tax reform.

Having perused the report of the Chief Economic Advisor (CEA), Arvind Subramanian, in detail on setting a revenue-neutral rate (RNR), what one can’t miss is that with all the best intentions, the rate fixing is still like a shot in the dark and then hoping that the system responds. The amount of revenue I believe that is envisaged to be mobilised from GST in toto is to the order of around 7 lakh crore, given the current assumptions like keeping fuel, alcohol, tobacco, etc., out of GST, with the states and the Centre roughly mobilising 50 percent each.

This piece is a suggestion on setting the GST rates and then going forward, resetting them on a continuous basis, to fine-tune revenue collection based on the way the system responds.

The CEA has recommended an overall RNR of 15.5 percent, with a low rate of 2-6 percent, a merit rate of 12 percent, a standard rate of 18 percent and a demerit rate of 40 percent. An SME businessman friend of mine, Mukul Agarwal, has suggested the rates be as follows - a low rate of 4 percent, a merit rate of 8 percent, a standard rate of 16 percent, and a demerit rate of 32 percent.

I have to admit that there is a certain elegance and cadence about the construct of the rates which he has proposed. Having said that, I am equally aware that the process of setting rates has to be driven by more than just “visual elegance”, which we should therefore leave to the wisdom of the GST Council.

Once the rates have been set, we need to have a clear process by which changes will be made in these rates going forward. A suggested set of guidelines are as follows:

- The initial set of rates cannot be changed for a period of one year to allow the system to settle down and a clear picture to emerge on revenue mobilisation and whether the target will be met or not.

- Post one year, the GST Council will have the right to reset any or all of the four rates on a quarterly basis, but by no more than 0.25 percent at a time.

- The GST Council will also need to provide a quarterly policy review, like the RBI does, wherein it will comment on the general responsiveness of the economy to GST, sectoral issues, if any (e.g. in telecom and e-commerce), proposed re-categorisation of goods and services between either of the four rates along with the rationale, etc.

- All the decisions in the GST Council should be on a “secret ballot” basis, i.e., the proposed rates for each level should be voted upon by the Centre and the states, in confidence, and a weighted average of the rates based on the vote and the allocated vote share would decide the final rate. This way one can be assured that no state, large or small, will feel bulldozed into a decision that they did not want.

The process outlined above will make this exercise smooth and also allow for a continuous and moderated fine-tuning, rather than being ad hoc or volatile.

This piece was first published on LinkedIn and has been republished here with permission.

Views expressed above are strictly personal.