A comprehensive multi-stage value-added tax (VAT) system, the Goods and Services Tax (GST), was introduced in India on 1 July 2017. The GST encompasses various indirect taxes from union and state tax bases. In a federal system, the harmonisation of tax rules, regulations, rates, processes and procedures across states is expected to improve the ease of doing business, encourage investment and produce economic growth.
But the success of any tax reform depends on successful implementation and the ease of tax compliance. Without GST system stability, it is difficult to comment on the success of its revenue mobilisation.
It has been acknowledged that GST collection is falling short of the targets set in the Union Budget. The impact of revenue uncertainty is not restricted to union finances alone — it will spill over to state finances through tax devolution.
It is difficult to compare GST revenue collection with earlier systems of taxation. Given that the data available in budget documents and the Finance Accounts of state governments is disaggregated, it is not possible in pre-GST regimes to separate the revenue from sales tax, VAT, Central Sales Tax and entry tax into two separate baskets necessary for comparison. These two baskets would include items which are subsumed under GST and out-of-GST items (which includes five petroleum products and alcoholic beverages for human consumption).
GST also subsumes various taxes and cesses that used to be collected by local governments and other institutions and were not necessarily reflected in state budget documents. According to the Goods and Services (Compensation to States) Act of 2017, revenue from these taxes and cesses are to be protected and due GST compensation released to states.
GST revenue shortfall may arise due to problems associated with the design and structure of GST, policies and practices of GST administration and tax compliance. The multiple rate structure may have helped to moderate GST incidence across different segments of society but it is prone to classification disputes and tax evasion. Frequent reductions in GST rates may have improved tax compliance, but the revenue implications cannot be ignored. Frequent changes in the compliance requirements, processes and procedures may also delay stabilisation of the GST system.
There are several GST provisions which have not yet been adopted in practice. In the 32nd GST Council Meeting a decision was made to extend the annual turnover limit for GST registration under the composition scheme from Rs 10 million (US$140,000) to Rs 15 million (US$210,000) and to allow annual return submission. The tax rate for manufacturers under the composition scheme has been reduced from 2 per cent to 1 per cent.
The annual turnover limit for the composition scheme for services or mixed suppliers was extended to Rs 5 million (US$72,000) with a composition rate of 6 per cent. The GST threshold limit was extended from Rs 2 million (US$29,000) to Rs 4 million (US$57,000).
The revenue implications of these decisions are not notional or negligible — GST revenue collection is expected to bear the burden of these policy decisions. This will impact the Union’s finances through higher compensation payment obligations in cases where states’ GST collection falls below a 14 per cent annual growth rate (the rate of net revenue collected by the state from taxes subsumed under GST in the base year 2015–16).
On-time filing of returns is desirable to achieve stability in the tax compliance regime. The introduction of any new system of filing returns may impose additional costs for tax compliance such as procuring new software and training personnel to comply with a new system. This will further delay stabilisation of the GST return submission system.
Tax evasion could be contributing to a shortfall in GST revenue collection. Claiming input tax credit against fake invoices is the most common method of tax evasion. Under-invoicing is the result of collusive tax evasion mechanisms — sellers and purchasers mutually agree to under-report the value of transactions. To combat tax evasion, e-way bills were introduced in April 2018 to capture information on the movements of goods. But effective enforcement of the e-way bill system demands intensive monitoring, so revenue leakage cannot be ruled out.
A shortfall in GST collection is expected to impact gross tax revenue (GTR) collection in 2018–19 for the Union Government. It is unlikely that taxes from other sources (corporate and personal income tax) can compensate the revenue loss. So the size of the revenue shortfall is contingent upon improvements in tax collection from other sources and an increased compliance in GST. Any revenue shortfalls for the Union Government will impact state finances through lower tax devolution and grants-in-aid transfers.
The estimated shortfall in GST collection is Rs 1972 billion (US$28 billion) or 8.77 per cent of GTR in 2018–19. If the states’ shares of central transfers remain unchanged at 55.4 per cent of GTR, the expected fall in central transfers would be Rs 1092.54 billion (US$15.6 billion) in 2018–19.
If states do not increase their revenue mobilisation, they may be required to contain their expenditure to meet the Fiscal Responsibility and Budget Management Act (FRBM) targets. There may be demands from states for relief from the FRBM targets so that they can maintain present levels of expenditure. This could build up public debt and cause stress on state finances in the future.
The possibility of moderating the impact of GST revenue shortfalls by increasing the collection of other tax and non-tax revenues could be explored by the Union and state governments. But a lower nominal growth rate of gross value addition may be a constraint in improving tax collection. All in all, policymakers have work to do to ensure the stability of India’s GST system moving forward.