Most importantly, the goods and services tax (GST) collections, which represents the consumption of taxed goods and services, reached ₹1.05 trillion, an increase of 10% on a year-on-year basis, and the collection was the highest in the last eight months. The last time it had crossed ₹1 trillion was in February 2020.

The increase in GST collections comes as a great relief to both the Union and state governments. Although it is too early to assert that the trend will be sustained in the coming months, the increase seen in October raises hopes of increased fiscal space and reduced tensions on the compensation front.

The sharp decline in revenue collections following the economic slowdown, the most severe lockdown and subsequent controversy around compensation payments have taken the Union-state relationship to the lowest point. If the current increase is sustained, both Union and state governments can heave a sigh of relief as the states would have more revenues and the amount required for compensation will be less.

The increase was seen in central GST, state GST, inter-state GST as well as the compensation cess by varying magnitudes. The state collection figures show that every state has witnessed an increase in SGST. Among the large states, Andhra Pradesh, Chhattisgarh, Jharkhand and Odisha showed increases of more than 20%. In five states (Gujarat, Haryana, Madhya Pradesh, Punjab and West Bengal), the increase was more than 15%; and in the remaining, the increase was higher than 5%.

It is premature to assert that the increase seen in revenue collections will be sustained, but there are reasons to be cautiously optimistic. To attribute increased revenue collections to pent-up demand may not be entirely accurate as even by end August there were progressive relaxations of the lockdown in the entire country excluding only the narrowly-defined containment zones.

Again, many activities such as travel and tourism, hospitality remain suspended. Even in trade, footfalls in malls are still to pick up and economic activity in these sectors will pick up only when consumers are relaxed and confidence returns. This also cannot be attributed to festival demand as a large part of October was inauspicious according to Hindu calendar, Navaratri festivities were subdued, and Diwali is yet to be celebrated.

Of course, the economy is in a recovery phase and that can partly explain the increase, though the news on the employment front is not very encouraging and the levels of income and consumption are expected to be much lower than last year. All said, there are reasons to believe that the GST collections may continue to be buoyant in the coming months.

This then presents an ideal time to think about reforms in the structure of GST. These reforms will not only rationalize the structure, but also accelerate the recovery process. What steps can be taken to achieve this?

Technology factor

One possible factor to explain the uptick in GST collections could be the introduction of an e-invoice system. Although this has been done only for the taxpayers with more than ₹500 crore turnover per year, it signals an important step in the scrutiny of input tax credit. There are only about 48,000 taxpayers in the country with turnover of more than ₹500 crore, but their contribution to tax is estimated at more than 45%.

For example, information collected from Karnataka for 2018-19 shows that there were just 41 taxpayers with more than ₹500-crore turnover but they accounted for 59.25% of the total turnover that is taxed and paid 24.23% of the tax collected. The ratio of tax paid to turnover for large taxpayers works out to 0.48% as compared to the average for the state which stands at 2.36%.

Moreover, the share of input tax credit in their turnover could be large. Also, there is considerable possibility of misusing the system through fake invoicing by creating subsidiaries to avail of input tax credit (all this of course when the technology is not operational). If e-invoicing has invoked better compliance of the tax, the GST Council is well advised to expand the coverage under e-invoicing up to ₹50 crore within the financial year and up to ₹5 crore by June next year.

In fact, taking the Karnataka numbers again, the taxpayers with turnover above ₹10 crore constituted just 0.48% of the total number of registrants; they accounted for 80% of the total turnover and 65% of the taxes. It should be eminently feasible to expand the coverage. This is the only way to kill the fake invoice industry.

Alongside, the GST Council should immediately prune the exemption list and introduce the reverse-charge mechanism to broaden the base and improve compliance. Using technology in a non-intrusive way to prevent the misuse of input tax credit could turn out to be a game changer just like the way the introduction of the Tax Information Network (TIN) did for income tax in 2004.

Responding to the comment by the Comptroller and Auditor General of India that a large proportion of entities which were required to deduct the tax at source (TDS), simply did not remit the money to the income tax department, Vijay Kelkar who was the then adviser to the finance minister entrusted the task of TIN to NSDL which put together the system of monitoring the TDS payments.

The result was the sharp increase in the ratio of Centre’s direct tax revenue to GDP from 3.9% in 2003-04 to 6.4% in 2007-08, registering an average growth of 31% per year. Although it is premature to conclude that revenue collections from GST will continue to increase, surely stabilizing the technology platform will make a significant improvement in tax compliance.

The structure

In a recent media interview, the Union finance secretary has clearly stated the direction of reforms in GST which should be taken up by the Council. Although the compensation issue has created a lot of trust deficit between the Centre and opposition-ruled states, the spirit of reconciliation in the decision by the former to borrow and compensate the states for the loss of revenue provides some comfort.

Increasing revenue collections should infuse confidence in the GST Council to undertake the much-needed reforms in the structure of the tax.

The focus of reforms should be rationalization of the structure of the tax and measures to aid recovery. First, the rates need to be rationalized to avoid inverted duty structure where tax rates on inputs are higher than those on outputs. Electrical transformers, railway wagons, some textile products, plastic bags and solar modules are some of the items where rationalization is needed. There may not be any difficulty in rationalizing these rates.

Second, it is important to have a relook at the exemption list. At present, as many as 148 items under four-digit HSN classification (having almost 50% weight in the consumer price index) have been kept in the exempted list. The ostensible reasons for this are administrative ease, equity and to minimise impact on prices. Ways have to be found to comprehensively cover legal services in the tax net and to ensure better compliance of the tax by professionals like doctors, architects, and contractors.

Third, it is important to expand coverage by introducing the reverse charge mechanism (where the receiver is liable to pay the tax, not the supplier). With the stabilized technology platform and experience gained so far, it should not be difficult to operationalize this.

Fourth, it is important to reduce the number of tax rates. This lowers classification problems, minimises inverted duty structure and reduces administrative and compliance costs by making the tax system simpler.

Having a single rate would be ideal, but that is not likely to find favour in the GST Council. The fact is, over 81% of the countries that introduced GST since 1999 have opted to levy the tax at a single rate.

The way ahead

In the prevailing situation, as rightly observed by the finance secretary, it is desirable to reduce the number of tax rates into three—a general rate, a rate for “sin" goods, and a merit rate. It is not difficult to compress 12% and 18% rates into 15% without sacrificing any revenue.

At the same time, there is an urgent need to prune the list of “sin" goods which are taxed at 28% and additional cess at varying rates prevailing at present. The most important items that should be taken off the “sin" list are building materials and passenger automobiles. It is unfair to think that by purchasing cars and constructing houses people are committing any sin!

Taxing these items at the general rate would greatly help in economic recovery by relieving substantial burden on these sectors. Construction and auto sectors are employment intensive and have high multiplier effects. The Union government could use its persuasive power to initiate these reforms in the GST Council.

An important reform needed to impart greater competitiveness is to comprehensively relieve all domestic trade taxes paid on exports. This requires the inclusion of electricity and petroleum products in the tax net.

Taxes on consumption and sale of electricity is specifically assigned to states in the Seventh Schedule (entry 53) and, therefore, including this as a part of GST requires removing this from the State list and putting it along with other taxes included in the GST. Electricity is a major input in the manufacturing process and relieving the tax on it is important to ensure export competitiveness.

Similarly, petroleum products should be brought into the GST fold as taxes on transportation of goods and services cannot be released on exports until that is done. Transportation costs and taxes paid thereon enter the production-distribution process in a big way. And inclusion of these items also makes the input tax credit mechanism more comprehensive.

Of course, there are revenue considerations as taxes on petroleum products constitute a substantial proportion of central and State consumption taxes. One way to deal with this is to have a separate excise on these items to safeguard revenues.

Often some bad features such as low threshold, excessive exemptions and multiple rates get into the tax structure for successful adoption of the reform, but it may prove to be extremely difficult to remove them.

The best time to undertake such reforms is now, when the economy is the recovery phase and when revenues show an increasing trend. The Union government should lead the reform initiative by persuading the states in the GST Council.