The Dangerous GST Race To The Bottom

Revenue shortfall for April-December, 2018 stands at an immoderate Rs 4,77,000 crores as against the target of Rs.13,48,048 Crores. This is likely to have a significant impact on the fiscal deficit especially because the central government has withstood higher revenue shortfalls than States.

GST rate reductions last year has already cost the country Rs.80,000 crores. Despite this, somewhere in Oct 2018, the race to the bottom began with extensive tax rate cuts in each of the GST council meetings. The recent announcements by the Prime Minister and the Finance Minister of further reducing rates of even the luxury items will only add a further burden on the people of India.

This raises two questions, on the efficacy of the process of decision making as well as the timing of the decision. Are decisions being made on the recommendations of the fitment committee after studying their impact? If so, are they flawed or is it a strategic decision for shoring the fledging revenue decline? Can the country afford such largesse or is it downright political irresponsibility wilting under the pressure of performance in the upcoming lok sabha elections, a few months away?

Rate fixing is done by the fitment committee undertaking an econometric exercise to study the impact of each proposal on how it compares to the RNR, its revenue impact and whether it creates a negative input tax credit situation etc. The cherry picking being done since the Oct 29^th GST Council Meeting in dropping GST tax rates gives an impression that it does not have the concurrence of Fitment Committee or at least, has been done without proper studies.

Adhocism not only sets a wrong precedence but undermines the processes instituted to protect against such decision making. It must be said that GST is as much a political issue as an economic one. So, some decisions could justifiably invoke a political sanctions but cannot be done on a mass scale.

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Moreover, there do not appear to be political pressures or compulsions for reducing luxury items like dish washer, air conditioners. So, timing makes it obvious that political appeasement has taken precedence over financial prudence.

Dire Financial Crisis:

All indications point to India facing a dire financial crisis. The Government’s unprecedented step of dipping into RBI pockets confirms this. Moreover, the country has been able to collect revenues of not more than an average of Rs. 88,000 Crores per month for the last 17 months as against a target of Rs. 1,20,000 crores per month. In addition, the country has lost significant revenue during transition to GST due to its poor implementation and the impact of demonetization.

Globally, most countries attempt to protect at least the current revenue streams of Governments (RNR)  before their transition to GST. In India, it is estimated that the Service Tax revenue would have increased from Rs 2,80,000 Cr to Rs 3,00,000 Crores p.a. in the conventional tax in the absence of GST. What is worrisome is that most of the collections have fallen short of the desired RNR. Central Government needs revenues to compensate the states that cannot achieve the targeted revenue growth. Given such liabilities, the race to the bottom will only have severe adverse impact on the country.

Identifying Delinquencies

It is likely that the next GST council meeting is contemplating reduction of cement rates from 28% to 18%. This well-intended initiative of decreasing the cement GST rates is based on the assumption that it will create jobs by giving a fillip to the construction industry. Construction industry employs five times more people than the combined employment in the next four or five sectors. Therefore, it makes good rationale sense to stimulate the real estate industry.

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The problem however is that there is a huge stock of building assets available in the market. There are no buyers in the market. Without liquidation of existing stocks, no builder will undertake construction. Moreover, Land accounts for a major share of the real estate costs making Indian real estate one of the highest priced in the world. Unless these fundamentals are corrected, what is the efficacy of reducing cement GST taxes?

The crux of the problem is that, barely 60% of the GST taxpayers are filing returns.Of the 1.2 crore GST taxpayers, the top 5000 account for roughly 90% of the revenues. Delinquency has increased. Why? The odds are in favour of the dishonest businessmen.

Evasion of tax and corruption are sides of the same coin. In an effort to correct excesses of “License Raj”, the design of the GST has envisaged not investigating more than 5% of the cases, ensured that no arrests can be made and even if caught, penalties are not punitive enough to instill fear in the businesses. In reality there have been as much or more excesses by errant taxpayers. So, the odds are in favour of the defaulter as the probability of getting caught are very low.

The Remedy And Suggestions

So, what should be done to correct this situation? There is a paradigm shift required in focusing on the few who account for 90% of the government revenues and 85% of tax liability is discharged by debiting Input tax credit. It is clear that 95% of the small businesses with less than 5 crore turnover account for less than 10% of the government revenues. As it is,Government is struggling to get enough CAs, officers etc. for audits. Even a 10% compliance increase in this segment can yield substantial revenues

The way forward is to focus on decreasing compliance costs and not to focus on tax reductions. Also, GST is complex and needs to be simplified. This can be done by plugging the fountainhead tax avoidance by providing incentives to the end consumer for demanding bills.

Japan recently introduced a scheme to provide points (which can be used as fares for bus and other such activities) to its citizens for discarding their plastics into dispenser machines.

Likewise, Indian consumers who provide Pan cards for billing can be automatically credited points that can be used to offset their IT payments, or discount on electricity bills etc. With benefits accruing to the consumer, the weak link of compliance will reduce significantly.

In short, instead of harnessing the weak compliance issues, playing to the galleries will only set off a lose-lose cycle to the detriment of the country. Good economics will always be good politics.

Disclaimer: The information, ideas or opinions appearing in this article are those of the author and do not necessarily reflect the views of N4M Media.