So far, the GST Council has got it right

The GST Council has finalised the rates for almost all the commodities, as well as the rates for services. The Council has approved five-tier structural rates — 0, 5, 12, 18 and 28 per cent — for both goods and services.

While the five-tier structure was expected on the goods side, a similar rate structure for services has come as a bit of a surprise. Nevertheless, one message that emerges clearly is that the broad rate structure especially on the goods side, far from being inflationary, may encourage a downward movement in prices.

This combined with already low levels of CPI inflation and strengthening of the rupee provides space for a looser monetary policy regime. Fiscal rectitude now may afford the Reserve Bank of India the luxury to move towards a more accommodative monetary policy and perhaps cut the rates. This will afford considerable relief to the private corporate sector and stimulate private investment.

Besides this general message, there are two interesting decisions on the rates which merit elaboration. First of all, the GST council has approved a levy of 5 per cent GST on unmanufactured tobacco in the hands of the purchaser. This is an important measure as it recognises that from the health point of view, all tobacco needs to be treated uniformly for tax purposes without discriminating between product categories. The measure will also bring in discipline in the tobacco auction market and create an audit trail of transactions which will reduce non-compliance in sectors such as bidi, chewing tobacco and cigarettes. It may also bring in much needed revenue to the extent it finds use in the exempted product category.

The other interesting decision was fixing a duty rate of 12 per cent for works contract relating to construction of residential/commercial buildings when the full value of the land is included in the taxable base. Full input duty credit has been allowed whereas hitherto no credit was given on input goods. This measure could be the precursor to the inclusion of real estate in the GST in the next round.

This will bring the full value chain in the real estate segment within the GST which until now was restricted only up to the construction stage. It will remove the present artificial distinction in services taxation between works contract and services rendered in relation to construction of residential/commercial buildings. This will help clean up the land market and reduce the generation of black money income by bringing in greater transparency in transactions.

The duty rates on two important segments, namely gold and gold jewellery and textiles, have not been finalised; the decision has been postponed to a June 2 meeting in New Delhi. The traditionally low rates of excise duty/VAT on gold and gold jewellery are predicated on the premise that an increase in rates would encourage smuggling of gold into the country.

This argument does not hold much water now. Domestic prices of gold are a function of the level of international prices abroad and inflationary expectations at home. On the international side gold has ceased to be an attractive store of value given the emergence of new financial instruments such as digital bitcoins and low levels of inflation. The relative strengthening of the US dollar makes gold even less attractive.

Within India, inflation is at an all-time low. The Government’s Jan Dhan Yojana has given the poor greater access to credit, and their financial inclusion will make gold less attractive. For all these reasons, this is probably the appropriate time to raise the duty on gold and gold jewellery to at least 5 per cent, if not more. This is only the headline rate and the effective rate may be lower if embedded credits of taxes in the supply chain are available post GST.

Regarding textiles, a great opportunity presents itself to clear up the multiplicity of rates. A uniformly low rate of duty of, say, 5 per cent across the value chain would remove the existing distortions and allow the rapid growth of the sector. One principle that has guided the fixation of rates of indirect taxation is the rich-poor dichotomy. The conventional wisdom has been that goods consumed by the rich should be taxed higher than goods consumed by the poor. While this argument appears attractive on the surface, in fact it may have an adverse effect as many of the products consumed by the rich are produced by the poor. Garments are a good example of this.

What was conspicuous consumption yesterday is mass consumption today and therefore these categories over time segue into one another. Historically, the textile industry is a good example of how wrong policies adversely affected the growth of the sector. At Independence, the textile industry was poised to become the leader in Asia but high rates of import duty on textiles machinery and a policy of reserving textile items for the smallscale industry effectively prevented the emergence of large textile companies in the seventies; the space was taken over by China, Taiwan and South Korea. Today another opportunity presents itself for simplifying and lowering the rates and maintaining fibre neutrality.

The debates over the fixation of rates are illuminating. While the proposed structure definitely represents an improvement, we need to move to even fewer rates of duty in the GST. Historical experience shows us that indirect taxes are not a good instrument for achieving socio-economic objectives with two important caveats. One, higher rates could be justified on environmental grounds, while lower rates could be justified for labour-intensive sectors. Other than this, the poor/rich argument should be jettisoned, for egalitarian objectives could be better addressed through the direct tax route than through the indirect tax regime. The best way to ensure that the well-to-do contribute their share to tax revenues is by bringing them into the tax-net and subjecting income tax payees to a graded tax system based on income.

The time has therefore come to look at the differential role of direct and indirect taxes in achieving equity and investment objectives. The recently created ‘Tax Policy Research Group’ is probably well placed to look at the relative roles of direct and indirect tax revenues in the macro-economic scenario. There is another interesting area where GST by improving compliance in the trading segment can ensure buoyancy in the direct tax revenue.

There is no doubt GST is a transformational tax reform and a fine example of the concept of pooled sovereignty. A good GST can become a great GST with some additional policy measures.

The writer is a senior tax advisor at EY India. The views are personal.