The Centre needs to follow through with pending legislation for the goods and services tax (GST). As the recent Arvind Subramanian expert committee points out, the lack of reforms in the indirect tax regime leads to high costs and inefficiencies in myriad ways. For instance, blocked input taxes or distorting tax-on-tax and cascading rates could add up to as much as three-fourths of investment in plant and machinery.

Hence the pressing need to change over from the dual value-added tax (VAT) system in the Centre and the states to an integrated GST, with tax levied only on the value added and input tax credits seamlessly available across the value chain. It would shore up transparency and boost tax efficiency.

For starters, the government needs to respond to the three main points raised by the Congress: one, that a standard GST rate of no more than 18% be part of the constitutional amendment; two, an independent dispute-settlement mechanism be in place; three, that the additional 1% interstate tax be dropped. It is notable that the Subramanian panel does make a strong case for doing away with the 1% tax, but only as a small footnote in very fine print.

The panel estimates the revenue-neutral rate for GST to be 15-15.5%, with “a strong preference for the lower end of the range”. But the report flags other risks, like revenue shortfall, lower growth and even that the methodology of estimating the standard GST rate can be prone to error. The panel has called for a standard rate and a lower rate for merit goods of mass consumption, plus a still-lower rate for precious commodities like gold.

In addition, it has called for higher taxes of up to 40% on luxury cars and petroleum products, and similar ‘sin taxes’ on tobacco and potable alcohol. It is also notable that the committee backs tax on hitherto exempt heads like education and health.

The report is also explicit in recommending that exemption on excise duty and the like be done away with. Such exemptions amount to negative protection against import competition, as input tax credit cannot be claimed. It makes perfect sense to widen the indirect tax base by including most goods and services, and to keep the rates low. Indirect taxes are by definition regressive, paid by all and sundry. We need to keep them moderate to encourage compliance and raise tax buoyancy going forward.

The report mentions that no input tax credits are allowed for the Union excise duties on capital equipment acquired for use in such vital sectors such as transportation, infrastructure or construction. And the reason for the glaring anomaly is that these sectors are perceived to be outside the scope of manufacturing. The report adds that in 2014-15, of the total investment in plant and equipment by the non-government, non-household sector of about Rs 7.4 lakh crore, “blocked input taxes could amount to as much as 75% of total investment”.

The fact of the matter is that we still have a high-cost tax structure thanks to cascading rates and tax-on-tax. The way ahead is to reform the indirect tax regime with GST. A standard GST rate at 16% makes eminent sense. Also, a lower rate of 12% (6% each for the Centre and states) for select goods of mass consumption may be considered. And precious metals can be levied 4% (2% + 2%).

As the report points out, the GST Bill does provide a 2% band for the states above the standard GST rate, for tax flexibility. But varying rates can distort and divert economic activity. The GST Council needs to work at uniform rates so as to have a truly national market. It also needs to decide on a date for including key petro-products in the GST regime.

Such items do provide disproportionately high tax revenue for both the Centre and the states. But given the polluting externalities of petro-goods, along with the standard GST rate, a top-up non-Vatable rate of, say, 24% would make sense. A similar rate structure can be envisaged for potable alcohol and tobacco. In due course, it would also make sense to include electricity duty and real estate in GST.

As for the issues flagged by the Congress, a rigid GST rate in the constitutional amendment is unwarranted. It also makes sense for the political executive to resolve tax issues via consensus and, if need be, by setting up an expert committee. With regard to doing away with the 2% central sales tax, it would make better sense to reduce it by 1% now and bring it to zero in, say, two years, as the Centre compensates the states for revenue shortfall, if any, for five years.