With enough states ratifying the constitutional amendment for GST, it is just a matter of time before the GST Council is set up and serious negotiations begin on the revenue neutral rate (RNR) as well as the standard rate and the commodities that will be taxed at the merit/standard/demerit rates.

While most states are in favour of an RNR higher than the 17-19% recommended by the Chief Economic Advisor’s (CEA) panel on GST, Finance Minister Arun Jaitley needs to push as hard as possible for lower RNR and a sharp reduction in the current exemptions given by both the Centre and the states—together, they add up to a whopping 2.7% of GDP.

Getting rid of these exemptions will dramatically increase the tax base for the Centre and the states and, more importantly, will ensure that manufacturing in India is not at a disadvantage. Matching an excise duty exemption on local production with a CVD one on imports sounds fair, but as the CEA panel showed, it results in a considerable disadvantage to local producers—the Congress would do well to side with Jaitley here since it opposed the 1% tax on the same grounds of its hurting local production vis-a-vis imports.

Apart from a higher RNR, and hence a higher standard rate, resulting in higher inflation, it lowers compliance—the panel found a 1% increase in the standard rate lowers compliance by 1.22%; based on its recommendations of the RNR and other rates, the panel had estimated better compliance could result in over R4.3 lakh crore of extra taxes for the Centre and states to share.

Though Jaitley would be loath to raise GST rates on gold after the long jewellers’ strike when an excise duty was imposed on the industry—it is important to keep in mind that was on account of the industry not wanting to maintain books of accounts—the GST, on the other hand, is essentially a consumption tax and it is regressive that gold purchases are taxed at 1-1.6% today while 80% of gold is bought by the top 20% in the country.

While State Finance Ministers may also not want to tax gold which they feel the middle-class buys, it is important to keep in mind the impact on the standard rate that is applied to most goods. If gold GST is raised from 2% to 6%, the standard rate can be lowered from 18.9% to 18%, which is good for both inflation-control as well as for increased compliance and therefore higher tax collections.

Jaitley may be tempted to agree to a higher RNR since his budget needs to provide compensation for states but, given the long-run benefits of a low RNR for the economy, it is important this money be found by cutting expenses in the budget or by accepting a higher deficit. For the same reason, the money required by the Centre and states for grand-fathering excise/VAT exemptions have to be funded from their budgets and not loaded onto the RNR.

Source: Financial Express