Extending GST compensation as a reform catalyst

News: The agreement to pay compensation for the loss of revenue was for a period of five years, which will come to an end by June 2022.

However, the states are demanding to continue it for another five years. Because, it was hoped that the tax structure would stabilise in the first five years, however, the reform is still in transition.

GST compensation cess Background: Read here

Growing mistrust between States and Centre with respect to GST compensation: Read here

Why State’s demand to extend compensation needs to be accepted?

The GST structure has many issues that need to be reformed, and the cooperation of states is very significant. Hence, it will be difficult to reform the GST structure without extension of compensation to states for another five years.

Thus, it is necessary not only to reform GST but also to provide comfort to States to partake in the reform.

What are the core issues in the present GST regime?

First, the technology platform could not be strengthened for a long time due to which the initially planned returns could not be filed. This led to large-scale misuse of input tax credit using fake invoices.

The adverse impact on revenue collections due to this was compounded by the pandemic-induced lockdowns.

Second, indirect taxes are the only major source of revenue for the States. Considering their increased spending commitments for public service delivery, states want to mitigate revenue uncertainty.

So, to address the issues in GST, the structure of GST needs significant changes.

What are the reforms needed in GST?

Firstly, almost 50% of the consumption items included in the consumer price index are in the exemption list. To broaden the base of the tax, a significant assessment of these items is required.

Secondly, it is necessary to bring petroleum products, real estate, alcohol for human consumption, and electricity into the GST fold.

Thirdly, the current Multiple rates GST structure complicates the tax system. For example, the present structure is too complicated with four main rates (5%, 12%, 18%, and 28%). This is in addition to special rates on precious and semi-precious stones and metals, and cess on ‘demerit’ and luxury items. It causes administrative and compliance problems, creates an inverted duty structure, and leads to classification disputes. Reforming the structure to unify the rates is imperative

What is the way forward?

The 15th Finance Commission had pointed out that the compensation scheme of applying 14% growth on the base year revenue provided for the first five years was far too generous.

The issue can be revisited and the rate of growth of reference revenue for calculating compensation can be linked to the growth of GSDP in States to ensure the comfort of minimum certainty on the revenue.

This will incentivise them to accomplish the reform in the true spirit of cooperative federalism.

Source: This post is based on the article “Extending GST compensation as a reform catalyst” published in The Hindu on 12th Jan 2022.

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