A progressive GST is easier to promise than achieve

This growth has generally kept pace with that of India’s  nominal GDP, although its promise was of higher buoyancy. It still leaves out nearly half the economy—most notably fuels, energy and electricity—from its purview. Even among the items covered, it has  too many exemptions. Perhaps that explains why its gross mop-up is still around 6.8% of GDP, although it is on a gradual upward trajectory. The number of registrations under GST rose from 0.65 million in 2017 to 15 million now. 

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Even after eight years, one can’t escape the feeling that GST is still a work-in-progress. Frequent changes in tax rates are unsettling and its multitude of tax slabs is a big problem. Its apex governance body, the GST Council, has met 55 times in the past eight years and has had to grapple with rate changes and item classifications on numerous occasions. A tax system should be stable and predictable, and hence such frequent tweaks are not healthy for this tax or the economy. Constant tinkering can lead to disputes in classification or interpretation, even  problems of discretion and outright corruption. Legal cases are mounting. 

The GST Appellate Tribunal was given formal birth in 2024, but is yet to be constituted. This has led to a growing backlog of appeals, with taxpayers turning to high courts, overburdening the judiciary and disrupting the dispute resolution mechanism, a key feature of this tax.

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The major conceptual issue has been the progressivity of GST, which is an indirect tax. The tax paid does not depend on the payer’s income, but only on the value of the good or service being sold. If we had a single GST rate for all goods and services, then it would be regressive. It would violate the requirement that a tax system has to be fair. The burden should be relatively higher on richer folks. 

Note the word ‘relatively’; it means that as a fraction of their income, the rich are expected to bear a higher burden than the poor. But since the poor spend almost all their income on consumption, a  consumption tax is regressive by itself. This is one of the main reasons that demands arise for exemptions and lower rates.

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A recent paper by professor Sacchidananda Mukherjee of the National Institute of Public Finance and Policy (NIPFP) analyses the distributional impact of GST using the Household Consumption Expenditure Survey (HCES) of 2022-23. The survey had a sample of 261,746 households and covers 390 consumption items. 

His main finding is that GST is moderately progressive based on multiple indices. The tax burden in rural areas on the bottom half is only 31% and is the same on the next 30% of the households. The top 20% bear 37% of the GST burden. In urban areas, the burden shares are 29%, 30% and 41% respectively for the bottom 50%, mid 30% and top 20% of households. 

This progressivity is mainly because the lower fractiles, both in rural and urban areas, spend more on food that is either exempt or taxed at just 5%. Thus, raising the rates on these lightly taxed items would disproportionately hurt the poor. Even merging the 12% and 18% rate slabs, which seems in the offing, would affect the poor. 

Note that in this research, the progressivity of GST is assessed using consumption data and not income. Progressivity is achieved without using income targeting through differential GST rates on essential versus luxury goods and by spatial variations that catch the urban rich who consume more durables and services. 

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India’s share of indirect taxes in total taxes has drifted higher in recent years. This has raised concerns about the regressive nature of taxation overall. The NIPFP paper shows that GST is not regressive because of its design. It might be worth recalling the classic 1976 paper of Anthony Atkinson and Joseph Stiglitz on the design of a tax structure with both direct and indirect taxes. They asked whether governments should rely on indirect taxes (like VAT or GST) in addition to direct taxes (like income tax), or just stick to an optimal income tax to achieve fairness, redistribution and efficiency. 

Their main result was that the latter works best under some idealized conditions and there is no need for any indirect tax. This is what purists swear by. But their result has caveats relevant to the real world. For instance, if the rich and poor consume very different baskets of goods, then taxing luxury items helps redistribution. Or, if lack of information or a large informal sector makes tax implementation difficult, then indirect taxes can be more effective; they can be made progressive too. 

India’s pending GST reforms include a reduction and rationalization of its rate slabs and the expansion of its coverage. A consumption tax can at best be mildly progressive but cannot be used for redistribution. Simplifying and reducing rate slabs, which is imperative, will make progressivity harder to achieve. Achieving it by using a basket of goods consumed as a proxy for household income is unstable. It is also paternalistic, for it punishes households that are aspiring to and adopting luxury goods. And with better means of gathering income information, surely focusing on direct taxes is a better way to pursue fairness and tax efficiency. 

The author is senior fellow with Pune International Centre