This is how Sushil Kumar Modi, Bihar’s finance minister and chair of the Empowered Committee (EC) of State Finance Ministers, summarised his description of the design of the Goods and Services Tax (GST) at a recent meeting with national chambers and tax professionals. The price he had to pay to win consensus of the foot-dragging states was to make it so banal and insipid that it would largely preserve the status quo of the taxes that they levy. He might succeed in making GST inevitable, but it will not be a “game-changer”, only a “name changer”. It is not something that will set the Indian economy free from the cage of the Hindu rate of growth.

Under the EC model, GST will have two components: one levied by the Centre (CGST), and the other by the states (SGST). Both will apply to a common base of goods and services. Goods will be classified in four baskets: exempt from tax, taxable at a nominal rate (mainly precious metals taxable at one to two per cent), taxable at the concessional rate, and taxable at the standard rate. The base for goods, as well as their division into the four baskets, will be the same as what it is under the value-added tax (VAT) currently levied by the states. The status quo will also prevail for the base for services. The current base for the service tax levied by the Centre will be adopted for both CGST and SGST, except that it will be broadened to include those services currently under the exclusive domain of the states (for example, movie admissions).

This status quo for the base would mean no tangible reduction in tax-cascading that occurs through taxation of raw materials, parts, and capital goods acquired for use in production and distribution in exempt sectors. GST has been estimated to provide a boost to the gross domestic product of 0.9 to 1.7 per cent, but all of this is critically dependent on a substantial reduction in cascading.

There will be no GST on real property and, thus, no credit or offset allowed for the building materials and equipment acquired for use in commercial and industrial construction. Petroleum will come within the scope of GST under the Constitution, but is kept outside the GST law at least initially. There will be no credit for the taxes on exploration, development, refining or distribution of petroleum. The alcohol industry will continue to suffer the pain of cascading in perpetuity since it will be excluded (exempted) from the GST domain within the Constitution itself.

Exemptions are rampant in the service sector, as well. The most notable is the exemption for virtually the entire infrastructure sector. This means no offset for the taxes that get embedded in the cost of highways, bridges, railways, and international shipping. There is speculation that electricity generation and distribution may also meet the same fate. Health and education sectors are also exempted, but the amount of cascading in these sectors is relatively small.

The Central Sales Tax (CST) and the entry tax are other major sources of cascading under the current system. Both of these were to be subsumed under GST, except for an entry tax levied and collected by municipalities. The states have now sought a broader exception for the entry tax, i.e., for any entry tax in lieu of Octroi levied by the state. The states also remain apprehensive of revenue loss from the elimination of CST. They are actively considering options to continue it at two or four per cent.

With neither a pruning of the exemptions nor any change in the composition of the concessional rate basket, the revenue-neutral rate for SGST is being worked out to be close to the current rate, which is approximately 12.5 per cent. Assuming full harmonisation of CGST and SGST tax bases, the CGST revenue-neutral rate could also be in the 10 per cent-plus range, yielding a combined rate of 22.5 per cent-plus.

A tax at this rate would be bad economics and bad politics. It would erode compliance, and be susceptible to leakages and intense pressures for further exemptions. It would be a drag on the service tax, which would experience a near doubling of the tax burden from the current rate of 12.36 per cent.

For goods, the combined CGST+SGST rate would remain approximately the same as the current VAT plus the central excise rate. However, with conversion of the invisible central excise into a visible CGST, consumers would find GST twice as painful. Little wonder that Modi is soliciting advice from the national chambers on creative ways of hiding the tax from the consumers.

GST may be inevitable, but few would be enthralled by the model the EC has developed. State governments would be well advised to go back to the drawing board and put some politics back into the GST design by broadening its base and lowering the rates. Without it, GST will remain a mirage – a squandered opportunity for visionary reform of our tax system.