CEA’s report on Revenue Neutral Rate and GST structure: both bold and pragmatic

The much awaited report on GST Revenue Neutral Rate (RNR) is finally tabled. The report provides an excellent insight on the frailities of our existing indirect tax structure, which fragments India, creates an import bias and leads to sub-optimal productivity. While we still await the passage of the Constitutional Amendment Bill (CAB) amidst the political posturing, the dire need for a good GST is paramount for growth and “Make in India” to succeed.

The report summarizes well the distortions of original taxes such as Central Sales (CST) which lead to fragmented production and unwarranted depots in consuming states raising the costs of goods sold both due to cascading and increase in distribution costs. The report provides the analysis of six manufacturing states namely Maharashtra, Andhra Pradesh, Karnataka, Gujarat, Tamil Nadu and Kerala where this distortion affects 50% of their total trade flows.

We know stock transfers are a cost to business due to input State VAT credit reversals leading to cascading. Furthermore, some manufacturing states levy a 2% origin CST on inter-state sales, with an additional burden of VAT input credit reversals leading to further cascading. The demand of 1% cascading origin tax on inter-state supplies of goods by manufacturing states in the proposed CAB, probably stems from above potential loss of revenues.

The distortionary effect of 1% origin tax on inter-state supplies on goods though will be more damaging, since it will also apply on inter-company stock transfers. Hence, there is a need for its complete removal, which the report strongly recommends.

The report provides significant insights into various methodologies used for arriving at RNR. The report has defined what they mean as RNR differentiating the same from standard rate (the rate at which most goods and services are expected to be charged) to avoid confusion.

While we were all aware of 13th Finance Commission’s Direct Tax Turnover approach of “flawless GST” and a recommendation of 12% RNR, this report provides us with an analysis of the NIPFP report, which is more significant. The analysis of the NIPFP report becomes critical as The Empowered Committee of the State Finance Ministers has mandated the NIPFP for the RNR recommendations. There is clear disconnect in what NIPFP has recommended as RNR and what the political consensus wants. According to the latest report, NIPFP, basis the “indirect tax turnover” method, has derived an RNR of 17.7%. In a two-rate structure (which is what we may practically implement) will have a standard rate of nearly 23% (CGST+SGST). This rate is high and maybe politically unpalatable. This is lower than their previous derived standard rate of 27%.

The report has taken pains to validate albeit conservatively the NIPFP method to assuage the State concerns, which is welcome. The validation has factored the potential gaps in assumptions such as revision of State VAT base based on actual data, omission of sugar base, cascading effects and compliance efficiency.

The report surprisingly does not make any adjustments for textile sector contribution to an existing tax base although they admit that the effect of this sector is significant. This makes one wonder whether the final RNR of 12%–15% derived by the CEA has some inherent built in cushions.

Nevertheless, the recommended RNR does address the opposition demand of a reduced standard rate of 17%–18% in a dual structure with a reduced rate of 12%. The report also states that this RNR will have limited impact on inflation, which is a concern among large stakeholders though this remains to be evaluated on implementation.

The report points to an important fact of keeping the reduced rate closer to RNR to avoid political temptation of pushing more goods toward the reduced rate risking the standard rate to become higher and make compliance difficult (the ground reality in today’s State VAT where most goods are at a lower rate).

The CEA’s recommendations on GST design is equally commendable, namely the avoidance of rate bands in GST to ensure “Make in India” by “Making One India,” which is very critical. Moreover, the inclusion of rent-seeking sectors such as real estate and alcohol within the CAB (like in case of petroleum) while keeping the flexibility of taxing outside GST is equally important considering that governance without corruption is one the planks of the current government. Equally important is the inclusion of electricity in GST for improving industry competitiveness.

The report is a mirror to all stakeholders to really ponder and usher a good GST with ease of implementation at the earliest. The time has come for India to have an efficient indirect tax system for its economic aspirations.

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