• Notification Date: 30-11-2021
• Notification No: 65/2021-22

GST Council must realise that lower rates results in better compliance

The Finance Minister said last week that India needs to widen its tax base in order to boost collections because a wider tax base would lead to increased collections and an eventual reduction in tax rates. But could it be the other round? Would not lower tax rates drive increased compliance and higher collections, ie, the good old Laffer curve? Indeed, lower tax rates will also address the other major problem: subdued consumption expenditure by households and the return of cash.

The two are in fact related.  Even the most willing taxpayer is avoiding paying almost 20 percent more for household products, such as hair oil, toothpaste and shampoo etc. He and she are paying cash, instead.

Take another example: renovating a house. It mostly takes only two materials: cement and paint. Let’s say you need Rs 2 lakh worth of cement. If you were to pay GST at the 28 per cent rate that cement is taxed at, you would end up paying Rs 2.56 lakh. And for Rs 1 lakh worth of paint, you would pay Rs 1.18 lakh if you added in the 18 per cent GST.

Another way of looking at this is that a renovation that would cost you Rs 3.74 lakh would only cost you Rs 3 lakh if you paid in cash. 

So how does the government expect households, already reeling from drastic cuts in income, to increase consumption if white goods like fridges, air conditioners and TVs attract either 18 percent or 28 percent GST?

One could argue that most of these shopkeepers are small--with annual revenue well short of the Rs 40 lakh limit--and so are exempt from GST anyway.

But this exemption creates a problem. How do I, as the customer, know what the shopkeeper’s annual turnover is? How can I make sure he has to pay GST when he collects it from me, and doesn’t just pocket it?

To be sure, there are ways to ensure this. The customer can insist on a bill with the GST number of the business printed on it but how does one verify the number is genuine?

Many customers are instead avoiding this added complication in what should otherwise be a simple transaction and are just paying in cash.

Result: the government is not being able to capture these transactions when it measures economic activity; it is losing out on GST revenue; and it is failing in its overall mission of minimising the use of cash. 

The GST Council understood that blindly following the revenue neutral approach to tax rates was leading to inordinately high rates on items that should be taxed much lower. Instead, it chose to lower rates and push for increased compliance instead.

The current weighted average GST rate, according to the RBI, is 11.6 percent , significantly lower than the 15 percent revenue neutral rate recommended when GST was implemented.

Yet, GST revenue is at record highs, despite the pandemic. The average GST revenue for the first seven months of this financial year is Rs 1.16 lakh crore, the highest since GST was implemented. It was Rs 1.01 lakh crore for the full year 2019-20, the pre-pandemic year.

The finance minister, as Chairperson of the Council, must convince states to bring more items down from the 18 percent and 28 percent slabs. Doing so will not only increase compliance, but will also increase tax revenue through higher consumption.

She should be mindful of two things. One, tax officials always frighten ministers that revenue will fall if rates are reduced before compliance improves.

And two, to quote Jean Baptiste Colbert, a French finance minister in the 1780s, “that the act of taxation consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing".