Why does India need a simplified GST system?

India’s Goods and Services Tax might be updated 8 years after its roll out. But why does it need a revamp and should we consider the Singapore model today?

The late, former Finance Minister Arun Jaitley’s wish could finally come true!

In 2018, he said,

“The country should eventually have a GST which will have only slabs of zero, 5 per cent and standard rate with luxury and sin goods as an exception.”

Today, it looks like a 2-tier GST system with rates of 5% and 18% is finally on the anvil. Actually a three-tier system, because there could be a 40% rate on sin and luxury goods too (think tobacco and SUVs respectively). You could even say that the 0% tax on essentials is part of the system and therefore we have more tiers, but let’s not get too pedantic. Yet.

A proposal has been made, discussions are on, and everyone’s excited.

But to understand why this revamp is a big deal, we need to rewind a little bit.

See back in the day, every state in India had its own tax rules. So if you were transporting foods from one state to another, you’d have a central sales tax, then a value added tax (VAT) in the state, maybe an Octroi when the truck carrying goods came within city limits.

It was quite the challenge.

And the system even resulted in double taxation.

For instance, if your business is making cotton t-shirts, you might have first bought cotton to get things started. And you would’ve paid a tax on that purchase. Then, when you sell the t-shirt, there would be another tax on the final sale value.

But remember, the t-shirt is made of cotton which was already taxed. So the cotton component incurs a tax again.

If you think about it, the prices would be inflated too because of tax-on-tax.

It was quite a byzantine system at play that irked everyone.

Enter the new and shiny Goods and Services Tax. A reform meant to clean this mess up and create a “One Nation, One Tax” system.

And such was the anticipation around it that the government launched it in a very Independence Day-esque fashion, “at the stroke of the midnight hour”, on 1st July 2017.

But hold on…

The GST system wasn’t perfect either.

For starters, we had a whole host of GST rates —0% (for some essentials), 5%, 12%, 18%, 28%. Add to that the cess on certain goods that were considered sin or luxury. Then there were items such as fuel and alcohol which remained under state control too. So the system in itself sort of contradicted the ambition of a single tax across India.

And you could wonder, why did that happen, when even the pros had recommended a simpler structure from the very start?

Well, one argument was the ‘revenue neutral tax’ idea.

The fear was that moving to a GST system and its fewer tax slabs would bring down tax collections for the government and revenue would go for a toss. And lower revenues would mean that it would have to resort to greater borrowing to finance whatever infrastructure and other growth levers they had in mind.

So a whole bunch of rates and sub-rates emerged to keep the revenue as ‘neutral’ as possible.

But that wasn’t all.

People soon found out that tax rates were as convoluted as they come.

It could vary based on packaging! Remember the popcorn meme fest from last year? A packaged popcorn would be taxed at 5%, a ready-to-eat packaged popcorn would attract a 12% tax. And a sweet tooth craving for a caramel flavoured popcorn would mean you pay 18% tax.

It could depend on pricing! Such as 12% GST on movie tickets that cost less than ₹100 while it’s 18% for higher priced tickets.

It could even be on nomenclature! Such as flavoured milk being taxed at 12% with regular milk escaping the net. Whereas lassi, whether flavoured or unflavoured, being taxed at zero GST.

You get the drift, don’t you? GST wasn’t so simple after all.

And even if we move to a dual-tier system of 5% and 18% as being proposed, we might still be left scratching our heads quite often. So we’d probably need to keep all of this in mind since we’re overhauling the system, anyway.

But what if we could use this opportunity to do something even more radical?

What if we rationalise GST into a single tax rate system? Like Singapore!

The country has a 9% GST!

Sure, it does have a higher rate of tax on luxury and sin goods but ignore that and you get a singular tax rate.

And rather than having me explain why it doesn’t operate a multi-tier GST system, here’s something Singapore mentions in its government website. It actually references India indirectly to make its point.

A multi-tiered GST system leads to highly arbitrary distinctions between products, and creative efforts by businesses to get their products classified in lower tiers. Examples of disputes in other jurisdictions with multi-tier systems include whether mozzarella pizza toppings should be classified as “cheese” (and charged at a lower GST rate) depending on its vegetable oil content. This makes the system onerous to implement, unnecessarily complicating our GST system and increasing businesses’ compliance costs, which may eventually be passed on to consumers.

Yup, that pizza topping debate happened in India.

So maybe that makes sense. Maybe a multi-tier system only leads to people trying to find loopholes to get by.

But there’s more…Singapore doesn’t spare anyone. It even levies a GST on basic necessities. There’s no exemption.

Now I know, I know, you’ll be thinking,  “Singapore’s a developed nation. It doesn’t have as many people living in poverty as India does. So it’s an utterly ridiculous idea to not exempt any goods from tax. Moreover, it means the poor are taxed more for basic stuff.”

And that’s a legit argument.

But Singapore doesn’t buy into that argument. Because it thinks the most effective way to handle this dilemma is through the targeted use of GST vouchers.

We do not exempt basic necessities from GST in Singapore, because multi-tiered GST systems benefit the better-off more as they spend more on goods and services, including basic necessities. Such a system is also administratively costly to implement.

Instead, what we have is a fairer and more effective system. We collect GST from all taxpayers, including the higher-income households who spend more, foreigners residing in Singapore, and tourists. We then directly help the lower- and middle-income Singaporean households and seniors who pay GST for their expenses, through the permanent GST Voucher scheme and other subsidies/schemes. This approach is fairer and more effective, rather than waiving GST for some goods for everyone, whether rich or poor.

In a nutshell, everyone pays the GST. But the ones who aren’t as well off get cash deposits at regular intervals. Sort of a direct benefit transfer that India does with other subsidies. And that is meant to lower their burden relative to the rich folks.

Now we don’t know if a single tier system with no exemptions for basic goods can even work in India. It sounds like a utopian fantasy. And unanticipated hurdles can crop up in this case too.

But since GST 2.0 is on the cards, it might be worth looking into and debating, don’t you think?

PS: My colleagues in the Zerodha Markets team who write the insightful daily newsletter called The Daily Brief had a story about the potential GST reforms on Friday. Check it out here.

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This newsletter is written by Nithin Sasikumar.

Do read ‘Warren Buffett & Howard Marks on gold’ in our newsletter, ‘Second Order’ by Zerodha Varsity.

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