The recent upsurge in revenues offers the prospect of the country breaking out of the long-stagnant tax-to-GDP ratio
For the last 25 years, our tax-to-GDP ratio has been stuck at between 16 and 17 per cent, severely constraining our fiscal capacity to devote more resources to our underinvested sectors such as education and health. The State in a large country like India cannot discharge its developmental function with such a low fiscal capacity. Even at our levels of per capita income, we should be nearer to a 20 per cent tax-to-GDP ratio given the norms of other emerging market economies. Is there hope? I believe so.
The goods and services tax (GST) reforms offer the prospect of raising the tax-to-GDP ratio by at least 2 percentage points if we continue to build on incremental improvements in the information technology platform and also address the issues of raising the incidence of duties. There is no doubt that the recent uptick in GST revenues is largely due to better compliance prodded by the matching of invoices and better monitoring of permissions granted for registrations through physical verification of the premises and evaluation of the past income tax payment record. This has reduced the volume of fake input invoices. One indicator would be the cash-to-credit ratio of the duty paying units. A rough back of the envelope calculation shows that every month the GST duty payable amount is about Rs 5 trillion, of which Rs 4 trillion is paid through credit and Rs 1 trillion in cash. This makes for a cash-to-credit ratio of 20:80. There is now reason to believe that the improved compliance has pushed the cash component ratio from 20 per cent to about 25 per cent yielding an additional monthly revenue of Rs 25,000 crore. This is the reason why our new normal of GST revenues is Rs 1.25 trillion instead of the earlier Rs 1 trillion. This improvement needs a careful study which the Directorate General Analytics can do in collaboration with the Goods and Services Tax Network as they have all the data.
The other gains in revenues have come from the personal income tax collection. Better coordination between the two tax departments — Central Board of Direct Taxes and Central Board of Indirect Taxes and Customs — has helped boost collections. What has been especially useful is the declaration of the GST turnover in the income tax return, which has made revenue coordination possible. This has led to smaller units covering the unincorporated and the family units to pay greater amount of taxes. As the revenues paid by these units reflect in the personal income tax revenues, this category is showing better revenues and holding up even during this difficult Covid period. While better compliance has contributed to buoyancy in GST revenues, there is still work to be done.
The Fifteenth Finance Commission in its report based on an IMF study has said that the GST incidence of duty has fallen from 14 per cent — the revenue neutral rate — to 11.8 per cent. This needs to be corrected. There are a number of steps that need to be taken.
First of all, the large number of exemptions need to be phased away. When GST was implemented there were 90+ State VAT exemptions and about 390+ Central excise exemptions. We need to restrict GST exemptions only to those items that were VAT exempt in the pre-GST period. This was the consensus reached by the Centre and the states in the various committees created.
There is also a need to revisit the GST rates on tobacco and gold. Traditionally, taxation in the tobacco sector has been fixated on cigarettes. Even though out of a total annual tobacco production of 800 million kg, only 250 million kg approximately go into cigarette production. We need to raise the GST rates on tobacco, which is levied on reverse charge basis, from the present level of 5 per cent. This will increase the revenue to the extent tobacco is used in the manufacturing of exempted products. This will also signal the use of GST taxation as an instrument to curb tobacco consumption. On gold, there is a need to revise the GST rate of 3 per cent on equity consideration as more than 80 per cent of gold and gold ornaments purchased and owned is by the top decile of the population.
There is also the need to deal with the problem of inverted duty structure in sectors such as textiles and footwear. Finally, the real estate sector also needs to be brought under the ambit of GST. This will clean up the land market and increase the revenues more on the direct tax side as the GST rate would be more in the nature of clearing rate to offset the embedded input taxes.
Amidst the optimism about the gains in the GST revenues, there is also some evidence that the formal sector is gaining market share from the small and the medium sector. This is especially true for sectors such as FMCG and e-commerce and reinforced by the Covid situation. The small and medium industries are a vital component of the economy and provide jobs to millions. The economic interest of this segment needs to be protected. In order to ensure that large units buy from the small units, GST should be paid on supplies from the small to the large on a reverse charge basis so that the larger units get the benefit of input duty credit in the case of purchase from the smaller units. This provision was available in the early days of the GST implementation but was later restricted to a few sectors. This provision needs to be generally applied again.
In conclusion, the recent upsurge in GST revenue, nudged up by better compliance, can be sustained by rate changes to increase the incidence of GST duty to a revenue neutral level of 14 per cent. This offers the prospect of the country breaking out of the “Fiscal chakravyuh” of 16-17 per cent of GDP in the medium term. Meanwhile, the buoyancy in the GST revenues can sustain higher healthcare expenditures in the short run, which is welcome indeed.The writer is a retired member, Central Board of Indirect Taxes & Customs. Views expressed are personal