Time to think about shifting to a single-rate GST

What is a Kit Kat – a wafer with a chocolate coating or a chocolate with a wafer inside? Both are right, so one might wonder what’s the big deal. But this was quite a big deal as the question was decided by the Excise Appellate Tribunal in 1999. The tribunal said Kitkat was a wafer with a chocolate coating and attracts an excise duty of 16 per cent and not chocolate, as claimed by the tax authorities which attracts a 30 per cent excise duty.

Such disputes are frequent in a tax regime with varying rates, where authorities will try to extract the highest rate while the manufacturers tweak their products to place them in a category that attracts lower rates. Such disputes will be history if we adopt a single-rate expenditure tax, GST, in this instance.

Here, we will have a set of goods/services with no GST and the rest with a single rate—unlike our present system of multiple rates. Wouldn’t that result in a Rolex watch of Rs 2 lakh and a Timex watch of Rs 1,000 attracting the same tax rate?

Yes, but it won’t be a problem if income disparities are properly tracked and taxed by income taxes. A single rate GST was intensely debated but was dropped as it was assigned to do part of the job assigned to income taxes. Thus, we have GST trying to capture tax from income undetected by income tax authorities. This is the reason why goods and services are classified in a spectrum from essentials to luxuries and the former attracting no GST and the latter with the highest rate of 28 per cent. (But the reality is much different, with a 100cc scooter attracting the highest rate at 28per cent!)

The ideal tax system is a combination of progressive income taxes and a single-rate expenditure tax. When income tax is progressive, as income goes up, a higher proportion of that income is taxed. Thus, someone paying a 10 per cent expenditure tax on her Rs 1,000 Timex watch won’t feel outraged at another paying the same 10 per cent tax on her Rs 2 lakh Rolex watch. The Timex buyer knows that a bigger chunk of the Rolex buyer’s income is with the taxman.

As per CBDT data, the number of income tax payers in FY 22-23 was 10.40 crore, of which 95 per cent are individuals . In 2023-24, direct taxes (which chiefly comprise personal and corporate income taxes) were 57 per cent of total taxes, which is a 14-year high as against 43 per cent share of indirect taxes (which comprise chiefly GST, excise duty and VAT).

Thus, it’s time to think about shifting to a single-rate GST as the economy becomes more formal and income is captured and taxed with less leakage. Many economists have suggested a 12 per cent rate. Here, tax on those in the current 5 per cent slab goes up while those in the 18 and 28 per cent slabs come down.

Thus, luxury and semi-luxury goods and services will see a price drop, while more essential goods will see an increase in price. An easy way to compensate for the price rise is to reduce excise duty and VAT on petrol and diesel levied by Union and State governments. Since these fuels are directly or indirectly consumed by each one of us, the pain of 5 per cent moving to 12 per cent will be neutralised. Union and state governments won’t object to such a deal if the fall in fuel taxes is compensated with a rise in GST, which is a reasonable expectation.

But, a higher share of direct taxes collected by the Union government will lead to an even more intense fight over the quantum of taxes to be shared with the states and the share of each from it. Here, too, there is a simple solution. Currently, GST is shared equally by the Centre and States. Increase the states’ share and reduce the central share. Thus, a higher quantum of direct taxes to the Union is offset by a higher share of indirect taxes to the states.

A single-rate GST is easy to administer and collect. And at lower rates, the gains from tax evasion go down. Courts won’t be asked to define and classify chocolate bars. GST Council won’t have much to do, and hence, Union and state finance ministers can apply their energies to more important issues.