There is a great opportunity to keep the rates lower than the general expectations and pleasantly surprise the whole nation. The only concern one can have with lower rate is revenue loss. Nobody can gainsay positive impact of a low rate in terms of lower inflation, higher investment, faster growth and more employment.
Let us look at the experience of other countries. Singapore first introduced GST on April 1, 1994, with a rate of 3%, the lowest in the world. It was one of the key drivers for rapid economic and tourism growth. Singapore gradually increased the GST rate to 4% in 2003, 5% in 2004 and to the current rate of 7% in 2007. The average rate in the Asia Pacific is less than 10%.
Malaysia introduced GST recently in 2015 and policy makers there were expecting GST implementation to drive sales and service tax revenue of 1.6% of GDP in 2014 to about GST collection of 1.9% of GDP in 2015. However, actual numbers were a huge positive surprise and have brought in 2.3% of GDP as revenue in 2015. Now they expect GST to rise even further to 3.1% of GDP in 2016. The two key lessons are that start with a lower rate and do not underestimate the revenue increase from better compliance.
India can also start with low GST rates. The lower rate would mean lesser incentive for tax evasion and encourage better compliance. It will also help widen the tax base. As the structure of GST envisages use of PAN number and linking with NSDL database, compliance for direct taxes will also enhance. Just like Malaysia, India's GST revenue can surprise on the positive side as there are huge leakages in the system, especially at local octroi and tax collection machinery at state levels.
On the other hand, a high GST rate may arouse popular sentiment against it and compliance may not start on a good note.
Another important factor to watch will be GST's impact on inflation. Low GST rates will not stoke inflation and will boost growth and employment. However, in the wake of such high decibel debate on government and RBI stance on rate cuts and inflation, any rise in inflation will be a huge deterrent for the new RBI governor to cut rates. Higher incidence on services may not get fully captured in the CPI- inflation index but will hurt a much larger part of the population, being provider or consumer of services.
The low rates will encourage many new enterprises to expand, put in new investments and attract new capacity at micro and small level. With India becoming one market, a lot of possibilities will open up for small as well as large enterprises. Entrepreneur's investment is always driven by sentiment or expectation about future profit and not actual profits as actual profits are known only with hindsight long after the investment is made. A low GST rate will create positive sentiments all around and boost investment.
India was never better placed to take the risk of some revenue loss in short term. The government is sitting on a huge bounty from lower oil prices of the last two years. Politically also, lower rates will be difficult to be opposed and will garner public support — so essential for any path-breaking reform.
The implementation of GST will bring huge long-term benefits to the country. It will help superior and more optimal resource allocation, increase competitiveness in domestic production and exports, reduce, simplify tax structure and enhance ease of doing business and boost GDP growth by anywhere between 80 to 150 bps. It is therefore very important that the process runs smoothly and does not fall prey to negative public sentiment.
All Indians, from consumers to small enterprises and corporates to investors, are excited about the prospects of GST implementation. Now that the biggest hurdle of getting constitutional amendment approved by the Rajya Sabha is behind us, GST is just a matter of time. The most important factor for its impact and efficacy will be the GST tax rate. The Arvind Subramanian committee estimated revenue neutral rate of 15-15.5% and recommended a three-tier tax structure of 12% for essential items, 40% for luxury items and 17-18% being standard rate for most items.
A simple courageous call on keeping rates surprisingly low for instance 8% for essential, 16% standard and 32% for luxury items can be the real game-changer.
Nirmal Jain is the Founder and Chairman of IIFL.
This authored article first appeared in the Economic Times dated 15th August, 2016.