With GST, India is supposed to get one tax rate. But will it actually be four (plus cesses)?

If all goes according to Prime Minister Narendra Modi's plan, the long-awaited Goods and Services Tax will be a reality next year. The GST, which is meant to replace all indirect taxes like sales and service tax in an effort to turn India into a common market, cleared the biggest legislative hurdle with the passage of a constitutional amendment earlier this year. But it still has one big issue to tackle: what will the new tax rate be?

That is the main concern of the GST Council, which includes the finance ministers of all states as well as the Centre. But the Council three-day meeting ended Wednesday without deciding what that rate ought to be.

This is no simple discussion. The Centre has been hoping to keep the tax rate low, closer to the 18% mark, to reduce its impact on inflation and keep industry happy. The states, however, want a higher tax rate so that they get a larger share of the pie.

So, what should the GST rate be?

A committee headed by the Chief Economic Advisor Arvind Subramanian suggested in December keeping the standard GST rate at 18% with a revenue-neutral rate ranging between 15%-15.5%. The revenue neutral rate is the rate of taxation at which the states and the Centre continue to receive the same amount of revenue after GST is put in place as they currently do.

“The maximum possible tax base should be taxed at the standard rate,” the committee wrote, adding that inflationary pressures needed to be considered when deciding these rates. "The committee would recommend that lower rates be kept around 12 per cent (Centre plus states) with standard rates varying between 17 and 18 per cent."

The Subramanian committee said that there would be inflation if the GST rate is kept too high, due to a greater flow of money in the economy. Consumer price inflation in India is already hovering around the dangerous 5% mark, even as the Reserve Bank of India has been mandated to keep it under 4% in the next five years.

The states, however, have asked for a rate that is closer to 22%, suggesting that anything less will not leave enough revenues for them. The GST council over the last three days looked at five different proposed tax structures. This included the Centre's own recommendation, revealed by Finance Secretary Hasmukh Adia.

1. Lower rate, applicable to one-third of the taxable items – 6%.
2. Standard rate, applicable to more than 35% of taxable items – 12%/18%
3. Higher rate, applicable on items consumed by the rich and the upper middle class – 26%

Further, gold will be taxed at 4% while so-called demerit goods like tobacco and aerated drinks whose consumption is considered unhealthy will be taxed at the higher rate, along with additional cesses imposed on the goods.

The government is hoping to earn an additional Rs 50,000 crore from a high-end luxury good cess. This cess collection also takes into account the clean environment cess that the Centre will charge to exclusively compensate states for their revenue losses in the first five years of the GST losses. The government expects to collect Rs 26,000 crore from this cess.

What happens to inflation?

Inflation is among the key concerns voiced by both the Finance Minister Arun Jaitley and Revenue Secretary Adhia at the GST council, which consists of representatives of all states. Jaitley said that the broad approach revolved around keeping inflation at the current levels itself while also making sure that the Centre and the states have enough money to discharge their obligations.

“The broad approach has been that the rate structure should be such that it does not lead to any further CPI inflation, states should have adequate revenue and so also the Centre, so as to discharge their obligations, and this has to be blended with only the least possible burden which has to be put on the taxpayer,” Jaitley said.

Meanwhile, the RBI in its monetary policy committee briefing earlier this month said that timely roll out of GST is a challenging proposition and the implementation is likely to have a short-term inflationary impact on the economy. The central bank endorsed the Arvind Subramanian committee report while adding that the inflation could rise by 0.3%-0.7% if the standard rate is set at 22% or by a 0.6-%-1.9% if the standard rate goes up anywhere between 26%-30%.

“The general consensus is that the impact on consumer price inflation is likely to be moderate if the standard GST rate is at 18% in fact, overall price levels may go down due to more efficient allocation of factors of production,” the RBI said in its statement.

Will the states lose out on revenues if the standard rate is 18%?

Tamil Nadu is the among the few states in the country that is opposing the GST. It contends that the GST framework which imposes a countrywide tax code is “unfair, arbitrary, unconstitutional and illegal”.

The state’s Chief Minister J Jayalalithaa has consistently said in the past that the state’s revenue loss from the rollout of the GST could be as high as Rs 9,270 crore.

Meanwhile, other states such as Kerala that are manufacturing heavy, have been worried about the GST rollout as well since it is a destination tax – to be collected only where the goods are consumed. This would deal blow to the manufacturing states whose products could be consumed in another part of the country.

The government, however, has maintained that it is ready to compensate states for up to five years for any revenue losses they incur due to the GST rollout. Moreover, it has been trying to work out GST rates in a way that the government can pay the compensatory relief to states out of the GST collection itself.

“The revenue model should be such that it has some additional resources which could be used for revenue payment, for compensation payment to any losing state,” Jaitley said on Tuesday. The council reached the conclusion on Tuesday that the compensation to the states will be limited to the taxes subsumed under the GST regime.

Why cesses if GST is one-nation-one-tax?

While the government has been selling GST as a broad overarching tax structure that remains constant across the country, it has made it clear that it may not subsume all existing cesses under the GST – which run into 30 different categories generating about Rs 1.77 lakh crore a year – as it will push the rate higher up.

The imposition of an additional cess on luxury and demerit goods has not gone too well with Kerala whose Finance Minister Thomas Issac said that Centre’s plan “is in contradiction with the concept of the GST itself”.