GST and Revenue Neutral Rate

Because GST removes the problem of tax on tax and cascading effect of various taxes; and because GST is a value added tax, it is expected that tax collection would fall when it comes into effect. This implies that government tax revenue will come down when India moves to the GST regime. If the government wishes to collect the same amount of tax as in earlier tax regime, it needs to raise tax rate to make adjustments. This increased tax rate has been called the Revenue Neutral Rate (RNR).

What should be the revenue neutral rate? This has been a contentious issue. The government had set up several committees to arrive at such rate.  The initial panels (including 13FC) recommended that RNR should be slightly above 12%. However, states called this rate too low and objected because they would be bearing the brunt of low tax revenue collection.

Subsequently, a Delhi based think tank National Institute of Public Finance and Policy (NIPFP) was asked to compute the RNR. This think tank proposed a 26.68% RNR (12.77% CGST and 13.91% SGST). This rate is practically very high because globally, the average GST or VAT rate is around 16%. Thus, this number was neither politically not practically satisfactory. Currently, the deliberations are on to identify the most appropriate number which can be around 23 to 25%. The Congress party had asked the Rajya Sabha select committee for capping the GST rate at 18 per cent.

A possible implication of high RNR is inflation, which reduces the demand in economy and will affect rate of growth. The government cannot give up RNR because if it does so, its revenue would fall and states would suffer. This is the main worry of the states. We note here that the Centre has been proposing to compensate the states for their revenue losses but then, it will increase deficit of the centre.

In June 2015, a panel headed by Chief Economic Adviser Arvind Subramanian, was set up to prescribe a RNR which strikes a balance so that the rate is not too high for industry and simultaneously high enough, so that states do not suffer any revenue loss. The committee will also suggest the impact of GST rollout on inflation. The Committee is expected to submit its report in December this year.

Concerns of the States

The state governments have the following issues:

  • A lower GST rate might mar their existing revenues and they may need to look up to the centre for compensation.
  • They are not ready with the information technology systems and the administrative infrastructure.

Various state Governments have sought assurances that their existing revenues will be protected, fearing that  if the uniform tax rate is lower than their existing rates, it will hit their tax kitty. The centre believes that dual GST will lead to better revenue collection for States.