A delay in the rescheduling of the GST slabs could seriously affect state governments’ revenues as a five-year compensation mechanism for their GST revenue shortfall expires on June 30.
A long-awaited restructuring of the Goods and Services Tax (GST) to raise the revenue neutral rate (RNR), from just over 11% now to 15.5%, could be delayed by several months as high global commodity prices have led to a rise in inflation expectations among households and businesses and have critically reviewed the Reserve Bank of India’s (RBI) accommodative policy stance.
A delay in the rescheduling of the GST slabs could seriously affect state governments’ revenues as a five-year compensation mechanism for their GST revenue shortfall expires on June 30. It may also make it more difficult for the Center to resist states’ requests for compensation extensions to avoid a revenue shock to states. State spending, especially revenue, has risen in recent years in the wake of the pandemic, even amid severe revenue constraints.
“The suggestions of the group of ministers (GoM) on tariff rationalization will be vetted by the GST council. The changes in GST plates will be done in phases, taking into account inflationary pressures,” a senior official told FE, recognizing the difficulties of raising tax rates at the moment. In the meantime, officials are counting on continued growth in GST collections and anti-circumvention measures to narrow likely GST shortfalls.
The government is also aware that raising indirect tax rates on a wide range of products now could dampen consumption and hurt economic growth in the near term.
Under the GST compensation mechanism, which is constitutionally guaranteed, the states are guaranteed 14% annual revenue growth for the first five years after the tax’s launch in July 2017.
The group of ministers (GoM) led by the chief minister of Karnataka, Basavaraj Bommai, was unable to finalize discussions on the review of GST tariffs, leading to a delay in the report’s submission. The panel was composed in September 2021.
Given that the stakeholder consultation on the GoM report will also take time and that some key state elections such as Gujarat and Himachal Pradesh are scheduled for 2022, a comprehensive review of the GST rate may be delayed for a longer period of time.
While the council made some efforts to correct reverse tax structures in several value chains, the decision to roll back a uniform GST rate for textiles proved that this will not be an easy option.
The council had to drop a plan by the end of December 2021 to raise GST rates for most textile products in the man-made fiber value chain from 5% to 12%, amid protests from industry from Gujarat and other states. It may revisit the matter soon.
With commodity prices hardening after the Ukraine-Russia conflict, Indian wholesale price inflation (WPI) reversed course in February 2022 and rose to 13.11%, after standing at 12.96% in January. Retail inflation (CPI) also rose marginally in February to 6.07% from 6.01% in the previous month, hovering above the upper bound of the RBI’s inflation target of 2%-6%.
“It is essential to carefully consider all aspects, including the possibility of inflation, before deciding to rationalize interest rates. It is also necessary to establish the views of key industry stakeholders,” said MS Mani, partner at Deloitte India.
GST was intended to deliver significant incremental economic growth and improve revenue productivity. But revenues from this comprehensive destination consumption tax have consistently fallen below government expectations, due in part to the pandemic. Revenues improved in recent months as a result of the crackdown on evasion and formalization of the economy.
Officials are hopeful that average monthly GST collections would improve to about Rs 1.35 lakh crore from Rs 1.23 lakh crore in FY22, generating about Rs 90,000 crore in additional state GST collections in the next fiscal year .
There have been discussions about merging 5% and 12% GST tariff categories into a single 7% or 8% tariff, another official said. However, raising GST rates at this time may not be easy for commodities such as food products that are subject to a 5% rate.
An analyst pointed out that if the GST Council is to replace the existing four-rate structure – 5%, 12%, 18% and 28% – with a three-plate system, the peak rate of 28% is unlikely to be reached because it includes a few luxury items. The other option is to merge the rates of 5% and 12% to 7%-8% or to merge the plates of 12% and 18% to 15-16%. Again, 18% should not be changed as it brings in 70% of GST revenue. It is also possible that some items are now moved from 5% or 12% to the 18% slab. Some articles in the 5% category can also be exempted.
Although the GST compensation mechanism will expire on June 30 this year, several states have demanded that the facility be extended, Finance Minister Nirmala Sitharaman told parliament earlier this week. However, the Center reiterated that the legal requirement was only to compensate states for GST deficiencies during the first five years after the launch of the GST.
It also pointed out that only for the repayment of the loan taken out to offset the states for 2020-21 and 2021-22, the cut-off dates must be in effect until the end of FY26.
Following a decision by the GST council, the center has released Rs 1.1 lakh crore for 2020-21 and Rs 1.59 lakh crore for 2021-22 as back-to-back loans to make up the shortfall. The Center has mobilized the funds through loans under a special window provided by the RBI.
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