Proposed GST reforms aren’t next-gen but design flaws introduced in 2017

Prime Minister Narendra Modi promised next-generation GST reforms to reduce tax burdens on MSMEs, local vendors and consumers, which he said would stimulate growth and create a more efficient, citizen-friendly economy. He didn’t give the details, but the Finance Ministry did, in a statement immediately thereafter, proposing the very same ones that it did before rolling out the GST in 2017 – raising doubts about its sincerity again.

Also read: Centre to simplify GST, proposes 2-slab structure as part of next-gen reforms

Worse, the FinMin is silent on the fundamental requirement of filing any tax return – annual audited account of GST liabilities and refunds in this case – which it removed quietly from the original GST law in 2021. But before getting there, here is what the reforms promised now.

FinMin’s new GST reforms

The FinMin’s reform proposals are the following:

1. Correcting the inverted duty structure

2. Resolving classification issues to minimise disputes

3. Providing clarity, stability and predictability on rates

4. Reducing tax burden on common-use items and aspirational goods

5. Moving to a simpler tax with two slabs – standard and merit – and special rates only for a select few items

6. Ending compensation cess

7. Bringing seamless, tech-driven registration

8. Implementing pre-filled returns to reduce manual intervention

9. Faster and automated refunds

Besides, the FinMin said it was committed to working closely with the states “in true spirit of cooperative federalism”. National dailies added another element: the Centre plans two rates of 5 and 18 per cent and a sin tax of 40 per cent on tobacco.

Also read: GST, a landmark reform that reshaped India's economic landscape: PM Modi

All these reforms sound good on paper, except the GST was premised on these very promises, but when it was rolled out in July 2017, these were conspicuous by their absence.

Recall how it was rolled out at a midnight Parliament session, like the one India had seen when it gained freedom in August 1947. The Prime Minister called the GST “Good and Simple Tax” that would usher in “one-nation-one-tax”; his government presented it as “a second freedom fight”.

But the GST turned out to be one of the “twin shock” that derailed growth, along with the demonetisation of November 2016.

Also read: Gross GST collections double in 5 years to hit Rs 22 lakh-cr in FY25

A large number of small businesses were shut and business shifted from informal/MSME to formal corporate sector. The GDP growth plunged from 8 per cent in FY16 and 8.3 per cent in FY17 to 3.9 per cent in the pre-pandemic FY20 fiscal. Post-pandemic growth is even more K-shaped than it was earlier because the informal sector hasn’t fully recovered from the shocks.

Here is an account of how the design flaw let a Big Bang reform like the GST fail.

Multiplicity of GST rates

When the UPA initiated the GST, it was tentatively fixed at a single rate of 18 per cent. In 2015, then CEA Arvind Subramanian proposed three GST rates on the basis of global best practices – 12 per cent (Centre plus states) covering most items with two standard rates of 17-18 per cent – in his “Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST).”

But the GST was introduced with nine GST rates, which continue:

• Four main slabs of 5, 12, 18 and 28 per cent.

• One “composite” slab of 1 per cent for self-declared informal/MSME entities – for goods manufacturers with annual revenue of up to Rs 1.5 crore and for service providers with annual turnover of up to Rs 50 lakh.

• Three special rates: 3 per cent for gold, silver, diamond (polished) and jewellery; 1.5 per cent for cut and polished diamonds and 0.25 per cent for rough diamonds.

• One GST Compensation Cess over and above the others.

Even then, high-value petrol and petroleum products, alcohol for human consumption and tobacco were kept out; tobacco was later added but no the others. The next-gen reform promise is silent on their inclusion.

Constant fiddling with rates, questionable classifications

Recall last year’s brouhaha over the GST on popcorn – 5 per cent on plain popcorn, 12 per cent on salted and 18 per cent on caramelised ones. That year saw Coimbatore restaurateur D Srinivasan (Annapoorna restaurants) apologising to Union Finance Minister Nirmala Sitharaman after pointing out that a plain bun attracts 9 per cent GST but a bun with cream 18 per cent. In 2022, the Kerala High Court struck down 18 per cent GST on Malabar ‘parota’ (as against 5 per cent on bread). The court ruled 5 per cent on both, arguing that both are wheat products.

Every single year, the GST Council reshuffles tax rates – at times raising new ones. For example, in 2022, the GST council made history by imposing 5 per cent GST on food items consumed by the poor – unbranded but pre-packaged wheat, rice, curd, lassi, puffed rice, mutton and fish. India had never imposed such a tax on the poor.

Here is another example. Fresh and pasteurized milk attracts 0 per cent GST, milk and cream in concentrated form or containing sugar, milk powder/food for babies etc. 5 per cent and condensed milk, butter, ghee and cheese 12 per cent.

Such complications have been added over the years, making GST too complex and too unpredictable to be called “Good and Simple Tax”. A World Bank study of 2018 had said, India’s GST was more complex than the comparable systems in 115 countries, adding to cost of compliance and incentivised tax evasion.

Stability and predictability of GST

Every single year, the GST Council reshuffles tax rates – at times raising new ones. For example, in 2022, the GST council made history by imposing 5 per cent GST on food items consumed by the poor – unbranded but pre-packaged wheat, rice, curd, lassi, puffed rice, mutton and fish. India had never imposed such a tax on the poor.

Ironically, this came two years after the Centre started giving “free” ration to 813.5 million Indians to survive the economic hardships that the overnight, unplanned and badly managed national lockdown in 2020 and 2021 (Covid-19) caused – delivering the third economic shock (after the demonetisation and GST earlier). The “free” ration remains in force until December 31, 2028.

Unpredictable policy and tax regime scare away business.

Inverted GST structure and input credit tax (ICT)

Here is an example of inverted GST duty structure: Petrochemical inputs for man-made fabrics (MMFs) attract 18 per cent GST, yarns made out of those inputs 12 per cent but the final product, man-made fabrics, 5 per cent.

Higher input costs make final products costlier. Other than the ones at the base, others higher in the value chain can claim the GST back through the input tax credit (ICT) – a new element in Indian taxation.

Scan the newspapers, every month the Central Bureau of Investigation (CBI), Income Tax department and sundry anti-corruption agencies of states raid companies supplying fake ITC certificates to companies to claim and get GST refund. The ITC is also the reason why businesses shifted from the informal/MSMEs to the formal sector (easy to claim ITC and get a refund).

Why do such rackets endure after eight years?

In the initial few years, the main reason for this was technical glitches in the GST Network (GSTN). As a result, the Centre allowed automatic ITC refunds without cross-verification of invoices that the GSTN was to do automatically.

The GSTN has improved, but other problems remain.

Anil Sharma, a Chandigarh-based GST consultant, explains these reasons:

(i) Goods supply involves physical movement and verifiable, but not services – leaving scope for malfeasance in case of the latter.

(ii) Many states, like Uttar Pradesh, Bihar, Jharkhand, Madhya Pradesh, Maharashtra, Punjab, Rajasthan, West Bengal etc., have raised the threshold for filing e-way bills for movement of goods within state borders from Rs 50,000 (the Centre’s recommended level) to Rs 1 lakh. The e-way bills can be tracked (transportation companies and truck movements) but not invoices – the other option. Invoices involve only the two parties to the transaction and when they collude for mutual benefits, it presents a problem.

(iii) GST portal is not glitch-free and human interventions compound the problem – often causing data mismatch – which leads to non-refund of ITCs and supply disruptions. This brings corruption into the picture.

End to compensation cess

This cess should have ended in FY21 when the Centre stopped giving GST compensation to states.

In gross violation of the GST (Compensation to States) Act of 2017, the Centre refused to pay the compensation to states in September 2019 (at the Goa GST Council meeting), arguing that it was facing fiscal constraints. But the same month, the Centre announced a corporate tax cut of Rs 1.45 lakh crore.

The only credit the FinMin can claim is to reduce the number of GST returns to be filed in a year. From several hundred GST returns a pan-Indian company was required to file every year, it has come down to 60-70.

The Centre even borrowed money from the RBI to pay loans to states in lieu of the compensation – after first asking states to borrow money from the market to fill the gap. The Centre gave loans of Rs 1.1 lakh crore in FY21 and Rs 1.58 lakh crore in FY22. Thereafter, it stopped paying the compensation (or loan in lieu of it) but continues to levy and collect the Compensation Cess (until 2026) to replay its borrowed amount to the RBI.

Such developments were neither an example of “cooperative federalism” nor sound fiscal management.

The other reform proposals like seamless, tech-drive registration, implement pre-filled returns to reduce manual intervention and faster and automated refunds were also the promises made in 2017. The FinMin should answer why it didn’t fulfil it in the past eight years.

The most critical element to any tax system is integrity of the system. One critical element of that is auditing of business accounts. All corporations paying corporate tax mandatorily submit their audited accounts every year to the tax authorities.

But do you know this isn’t the case with GST?

No mandatory filing of audited accounts

The GST did provide for filing annual audited accounts – through the GSTR-9C form.

But this form was never rolled out and the deadline was extended every year until April 1, 2021.

Then, on July 30, 2021, the Centre removed this requirement altogether. Now, a GST taxpayer is required to file a self-declaration on the portal.

Now, if only foul play is suspected during the verification of GST filings, audits are ordered.

The FinMin should bring it back to give the GST a semblance of respectability as a tax system.

The only credit the FinMin can claim is to reduce the number of GST returns to be filed in a year. From several hundred GST returns a pan-Indian company was required to file every year, it has come down to 60-70.