Lighten the burden of indirect tax for the poorer Indian households

The Indian economy has been doing better than many large economies, including the Chinese and European Union, and that will have a positive effect on tax revenue. (Image: AP/Representative)

The next Goods and Services Tax (GST) council meeting could be an opportune time to assess the functioning of India’s indirect tax regime and address major concerns. More specifically, the GST burden on poorer Indian households troubled by high and sticky retail inflation needs lowering and multiple exemptions reduced to check market distortions. The latter would help widen the tax net.

Moreover, the Council must resist any pressure to raise GST rates that will add to market distortions. Similarly, a simpler filing and reporting regime will encourage voluntary GST registration by small and medium enterprises (SMEs) and aid compliance. That will give a boost to revenue generation without the need for raising tax rates.

Many argue that robust GST collection signals robust economic activities. The Indian economy has been doing better than many large economies, including the Chinese and European Union, and that will have a positive effect on tax revenue.

Robust Collections

GST is an ad valorem tax on domestic consumption i.e., it is charged at a fixed percentage of the price of a product or service consumed within the country. Therefore, irrespective of whether produced domestically or imported, the higher prices of products and services will lead to higher GST collection. India’s imports have been growing faster than its exports, and we are in the midst of a prolonged commodity market bull run that has jacked up the prices of most commodities including food, clothing, fuel and steel. That is bound to lead to a higher GST collection.

Besides, a substantial fall in the prices of the Indian basket of crude oil from about $116 a barrel in June to $82 in December has not translated into a corresponding downward revision in the prices of diesel and petrol. Petroleum products don’t attract GST. However, high crude oil prices and exorbitantly high excise and state value-added tax (VAT) on fuels raise the cost of transportation which attracts 18 percent GST. The higher cost of transportation in turn transmits cost-push inflation in every sector of the Indian economy.

Thus, most of this robustness in GST collection is due to the application of GST on inflated prices of goods and services. The other contributing factors are the withdrawal of GST exemptions on pre-packaged and labelled food products including curd and wheat flour and an increase in GST from 5 percent to 12 percent on works contracts for roads and bridges by the GST council at its 47^th meeting in June 2022.

Uneven Burden

On the other hand, poor Indian residents, who vastly outnumber the rich, bear a greater share of the GST burden (as highlighted by the latest Oxfam report) because a more significant proportion of their consumption basket is made of essentials that tend to have inelastic demand i.e., increased prices don’t lead to lower demand. As a result, the poor have to bear a larger share of the GST burden, even though the goods and services consumed more by them attract lower GST rates. In contrast, the consumption basket of affluent households has a bias towards discretionary goods and services that have a highly elastic demand which forces sellers to go slow on raising prices even when input costs increase.

To be fair, India’s GST regime tries to be progressive by imposing higher tax rates on goods and services consumed by the affluent and lower GST on those used by poorer households. That has led to too many GST rates, complicating the country’s indirect tax regime and inhibiting the growth of entrepreneurship. However, reducing GST rates for commodities used by the poor to lower their tax burden and/or raising rates on items consumed by affluent households will increase the relative gap between the lowest and highest rates. That will induce misinvoicing and aid corruption, and therefore is inadvisable.

Thus, inflation penalises the poor more than the rich, directly and indirectly through higher tax liabilities. Similarly, high fuel taxes and rising import tariff walls to support indigenous manufacturers aid cost-push inflation and increase the GST burden on all Indians including the poor.

Way Forward

The lowering of corporate income tax and continuation of too many exemptions under income tax laws have forced the government to rely more on indirect taxes, and GST in particular, to raise resources. But indirect taxes by their very nature are non-discriminatory and hence tend to be regressive. Similarly, high GST on common industrial inputs such as steel (18 percent) or cement (28 percent) or high excise and VAT on diesel and petrol aid cost-push inflation and hurts the poor more than the rich.

This doesn’t mean nothing can be done to reduce the tax burden on the poor. The solution is not to lower GST rates applicable to goods and services used more by the lower income households or raise them for items consumed by the affluent households, but to rely more on direct taxes such as corporations tax and personal income tax, and rein in inflation by sticking to a tighter monetary policy regime and cutting fuel taxes.

Raising corporation tax rates should be resisted as that would act as a disincentive at a time private investment remains sluggish. Similarly, raising income tax rates or introducing wealth tax (which was abolished in 2015) aimed at taxing the rich more is unadvisable as the top personal income tax rate including cess and surcharge is already too high.

However, pruning income tax exemptions to a bare minimum to widen the tax net, starting with taxing the rich farmers who appropriate most of the input subsidies, and benefits of steadily rising MSPs and assured procurement, and yet don’t pay any income tax, will help reduce excessive dependence on GST. There is no option but to prune the list of exemptions under both direct and indirect tax. Only that will help lower tax rates and ensure genuine tax reforms.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited. He tweets @RiteshEconomist. Views are personal, and do not represent the stand of this publication.