Amid concerns about a possible loss of revenue because of a reduction in the Goods and Services Tax (GST) rates, states must look at raising money through other means, including the levy of a Passenger and Goods Tax (PGT), said Sacchidananda Mukherjee, Professor at the New Delhi-based National Institute of Public Finance and Policy (NIPFP) in an interview with The Indian Express. While entry taxes such as octroi are subsumed by the GST, Mukherjee said states don’t use their authority to tax commercial movement of passengers and goods.
Mukherjee also discussed if the GST had become a more progressive system following the tax cuts that come into effect from Monday and how long one would have to wait to understand changes in consumer behaviour because of these cuts. Edited excerpts:
Your July paper assessed the GST as ‘moderately progressive’. Since then, the GST Council has announced a wide-ranging reduction in tax rates. Would they have made the system more progressive?
The rate reductions have been announced. However, there are issues regarding passing the benefits to consumers and the resultant changes in consumer behaviour. Depending on price and income elasticities of demand, the scale and composition of the consumption basket will change. The latest consumption expenditure data we have is for 2023-24. Therefore, to understand the impact of the GST rate changes, we will have to wait for the next Household Consumption Expenditure Survey.
My understanding is that the GST will be more progressive compared to what my July paper showed, since the tax rates have been reduced. The question is how much of the benefit will be passed on to the consumer and how long it’ll take. Unless there is a transitional (input tax) credit provision, there will be a cash flow problem, and businesses may be reluctant to pass on the benefits to consumers. It also depends on the market structure: if there is no competition, then a company won’t pass on the benefit. The government is saying it will take up the issue with industry bodies. But an industry body is not a regulatory body; it cannot take disciplinary action against its own members.
What about the revenue loss for states? Bihar, for instance, saw 57 per cent of its own-tax revenue coming from state GST. The figure for Gujarat is also more than 50 per cent. Are some states going to be at risk fiscally, or will the consumption increase help them?
There are many positive forces at play here: price and income elasticities of demand will change the scale and composition of consumption baskets of consumers, and therefore the revenue profile of states. There is a possibility of increasing formalisation and tax compliance, and hence higher revenue mobilisation. Tax evasion is expected to fall as it is a function of the tax rate. There are opposing forces also. An inverted duty structure will result in a larger demand for refunds. Lengthening the exemption list will shrink the tax base. Therefore, the ultimate impact of the GST rate restructuring on the revenue will depend on the relative strength of positive versus negative forces.
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The benefits of the tax cuts will be realised over the years, whereas the revenue impact will be immediate. States will come to know the total impact on revenue by the third or fourth quarter of the current fiscal year. Before that, it’s challenging to understand the revenue implications because the festive season is coming, and there will be a surge in GST collections. So, the monthly data may not give a good picture of the revenue impact.
As for Bihar and Gujarat, they don’t have alcohol tax collections, so their dependence on the GST is much higher than that of other states.
In my opinion, instead of exempting a large number of items, they should have kept them at a lower rate to increase the tax base. I am not opposed to reducing the tax rate; however, I firmly believe that exempting any items is not advisable, except for those which are difficult to administer, such as fresh fruits and vegetables. This also happened with personal income tax, where the exemption threshold has been increased in the last Union Budget. When you have a very narrow tax base, the taxable goods or the people who pay taxes bear an unnecessarily high tax burden. This is against the modern taxation system, which says ‘broad-based, low rate’, or BBLR.
Could these GST rate changes force a reversal of the prohibition policy?
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I believe it is the right time for states to explore all possible options for their own tax revenue augmentation. Not just alcohol taxes, but also Passenger and Goods Tax (PGT). Many states don’t exercise their power of taxation over passengers and goods. PGT is a kind of service tax for the negative externalities caused by vehicles when they are running on roads. This is apart from road tax, which is for the damage caused to roads.
The movement of commercial vehicles results in pollution, congestion costs, and road damage. It is time states must explore introducing PGT. It is also required because motor vehicles are increasingly becoming electric, and there are no taxes on their inputs. States impose a tax on petrol and diesel for non-electric cars, but electricity duty for most charging points is either exempted or capped at 5-10 per cent. So, states lose out on revenue from the input side. Even the registration fee and road tax for electric vehicles are exempted in most states. The GST is also only 5 per cent, instead of 18 per cent or 40 per cent. Some states also reimburse GST collections.
In another 10 or 20 years, the tax from fossil fuels used in the road transport sector is likely to dry up. Other countries have a tax based on vehicle miles travelled (VMT). An automatic tax collection system will facilitate VMT tax collection, where the more you travel, the more tax you will pay.
Then there is, of course, the alcohol ban in some states. The banning of alcohol does not mean the state is dry. It is a revenue loss for the government and a revenue gain for the neighbouring states.
What other options do states have to raise revenue?
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A significant area of reform, since the implementation of VAT, is tax administration. Tax collection is a function of tax base, tax rate, tax compliance, and tax efficiency. Since states can’t change the tax base and rates, compliance can constantly be improved by pursuing the taxpayers. Tax efficiency will help you identify tax fraud and evasion.
So, state governments have to be proactive and strengthen tax administration. It will take information-backed and targeted intervention in tax administration to collect taxes. Several tools are now available, including the GSTN’s BIFA (Business Intelligence and Fraud Analytics), and the NIC’s GST Prime and E-Way bill analytics. So, they have to use these analytical tools to come up with actionable cases of tax fraud and evasion in the GST and act upon those cases. This requires investment in additional manpower, IT, skilling, and infrastructure. Most state tax administrations have vacancies of around 30-35 per cent of the sanctioned posts. They have to fill these posts, have a tax policy unit, and a data analytical unit. Then revenue can be generated.
We know from the statistics ministry that the next consumer expenditure survey will only be conducted after three years. Does that mean any detailed analysis of how the GST rate changes affect consumer behaviour will have to wait until 2027-28 or beyond?
Not necessarily. There is an alternative data set, which is quite good: the Centre for Monitoring Indian Economy’s Consumer Pyramids Household Survey (CPHS). However, the coverage of the items and sample households is larger in the National Sample Survey Office’s (NSSO) survey. Also, the NSSO’s coverage of durable goods is larger than that of the CPHS. If we don’t have the NSSO’s data, one can use the CPHS database to understand what has happened. But it is better to wait for the next round of the NSSO’s survey. If it happens in 2026-27 or 2027-28, (by) then the entire pass-through would have happened.
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Furthermore, if there is an income shock, it would also be reflected in that survey. Many sectors are experiencing a decline in turnover, mainly due to external factors, especially those with high external exposure. At the same time, increased demand for domestic goods and services resulting from the tax cut will boost income for all producers. The rise in the economic growth will be realised in terms of income at the hands of the consumers. Therefore, I believe it is better to wait for the next NSSO survey.
