GST rate rejig is a bold shift from revenue-neutrality to real reform, aimed at cutting disputes and boosting consumption
On states’ concerns, CBIC chief says compensation doesn’t arise as the revenue hit is a collective decision
Simpler compliance and calibrated tariffs are the next steps to widen the tax base and make Indian industry globally competitive
Even as the GST Council unanimously cleared the Centre’s proposal for GST reforms and the recent rate rationalisation exercise, some state governments have separately demanded compensation to offset potential revenue losses. Sanjay Kumar Agarwal, Chairman of the Central Board of Indirect Taxes and Customs (CBIC), pushes back on this argument, stressing that the move was a collective decision where both the Centre and the states agreed to take a hit in the larger interest of the economy.
“In case they felt their revenue should remain the same and they didn’t want to take any hit, they could have opposed the proposal, but they did not,” says Agarwal. “Once we agreed to take a hit in the interest of the country, so that consumption levels go up, the economy grows, and new jobs are created, it became clear that nobody has been harmed. Therefore, the question of compensation does not arise.”
The GST Council on Wednesday approved a dual tax rate structure of 5% and 18%, removing the 12% and 28% slabs. The new rates will be applicable from September 22. Prime Minister Narendra Modi had first announced the Centre’s proposal in his Independence Day speech, indicating that the reform would be undertaken before Diwali.
Kerala Finance Minister K.N. Balagopal, however, warned on Thursday that almost all states will face a revenue squeeze, arguing that unless the Centre addresses potential shortfalls, the broader economy could be negatively affected. He noted that while economic theory and the Centre suggest that tax cuts will spur consumption and boost revenue buoyancy, the actual outcome will depend on state-specific consumption patterns.
In this exclusive interview with Outlook Business, CBIC Chairman Agarwal discusses the rationale behind the rate rationalisation, the government’s push to simplify compliance for small businesses, the issue of cess credits, and why tariffs are no longer viewed primarily as a revenue tool. Edited excerpts:
Earlier, the view was that any rate rationalisation had to be revenue-neutral, which meant prices of some items would inevitably go up. But in the recent exercise, only a few items have been moved upward. What explains this shift in approach?
What happens is that whenever we undertake a reform exercise, we are normally constrained by keeping the exercise limited. In that process, real reform does not take place. If we impose too many restraints on ourselves, then reform cannot truly happen.
Fundamentally, when GST was introduced, items were placed at particular rates on the basis of the tax incidence on those items prior to GST—through central excise duty and VAT. That is why cement was taxed at 28%. But cement never really merited attracting 28%, since it is used in the construction sector. Other items like iron and steel, which also go into construction, were placed at 18%.
The philosophy at that time was to keep it revenue-neutral. But after eight years, if we conduct the exercise with the same mindset and constraints, then real reform cannot take place.
So, this time, that is the fundamental change which could result in a transformative reform. What was done was to address the fact that a lot of classification disputes were arising because of so many rate slabs—5%, 12%, 18%, and 28%.
For example, in the food sector, where the maximum disputes arose, items were either exempted or taxed at 5%, 12%, or 18%. This sector is constantly evolving, with new food products entering the market due to changes in manufacturing technology. These new products could be classified either by their common parlance or by their manufacturing process, leading to disputes, since classification is done as per the HSN code, which originates on the customs side. While some fine-tuning of classification is done there, in GST the same goods are spread across the tariff and attract different rates.
Therefore, the first thought was that we should reduce the number of tax rates. There should be a standard rate of 18%, and a merit rate for goods that deserve a lower rate because they are mass-consumption items. With that mindset, each item was examined and placed at an appropriate rate. Some goods, particularly luxury goods, have been placed at a special rate of 40%.
That is why this change in approach is fundamental. Real reform could not have happened if we had remained stuck in the earlier framework. For example, if cement was reduced from 28% to 18%, but kept at 20% to play safe, the reform would have been a non-starter. To make the reform effective, bold decisions were required. At some point after the introduction of GST, such a reform becomes necessary, and it requires strong leadership to provide the boldness to the revenue department to conduct the exercise. This way, real reform happens. It is not a reform in name only.
After the Budget, the Finance Minister mentioned that it was the Board that needed convincing on income tax reductions. Similarly, what convinced you to move ahead with a proposal that carries revenue implications?
For placing each item, whether bringing it from a higher rate to a lower rate, or from a lower rate to a higher rate, everything was very carefully calculated in terms of revenue implications. The entire picture was presented, showing that if we were going for real reform, this would be its revenue impact.
Once we got the signal that we should pursue real reform and not a reform in name only, because such opportunities do not arise again and again, a proposal was made by the Centre. It was then sent to the GoM, which had been set up for the rate rationalisation exercise back in 2021. We did not find any opposition to this, and it was passed unanimously in the GST Council meeting, because each item had been carefully placed at the appropriate rate.
For example, in food items, where the maximum number of disputes were arising, all food products are now subject to a 5% rate. This means there will no longer be disputes, even under the residual entry—“if not elsewhere classified”—which has also been placed at 5%. So, in the food sector, disputes will not arise in the future either.
Even though the proposal has been unanimously accepted, some states are still asking for compensation separately. How would you respond to that?
I will pose only one question. Are they supporting or not supporting? If they are supporting, then they are equal stakeholders. So it is not that only their revenue will take a hit; it is the Union revenue that takes an equal hit.
In case they felt their revenue should remain the same and they didn’t want to take any hit, they could have opposed the proposal, but they did not. Once we agreed to take a hit in the interest of the country, so that consumption levels go up, the economy grows, and new jobs are created, it became clear that nobody has been harmed. Therefore, the question of compensation does not arise.
Compensation is sought when someone is harmed. Here, nobody has harmed anyone. It was a conscious, collective decision: you are taking the hit, I am also taking the hit. If I hit you, then you can seek compensation. But if we are jointly party to the decision and no one is opposing rationalisation, then the issue of compensation simply does not arise.
But can there really be a serious boost to consumption when real wages remain low and household debts high?
I do not look at it from that angle. Whatever revenue implication figures are coming out in the media from different stakeholders, ultimately that money is going to be placed in the hands of consumers. Once it remains in the economy, it will be spent again, creating multiple cycles.
This will not only generate revenue but also increase consumption. When consumption goes up, economic activity increases, jobs are created, the economy grows, GDP grows. That is the way the country progresses. It stimulates growth.
While it may be easier to ensure pass-through with bigger items, the challenge will be with smaller items, especially at the local level. In the absence of an anti-profiteering mechanism, how will you ensure the benefits actually reach the last mile of consumers?
The tax departments will be watching the price trend. In case we notice that, in a particular sector, rate cuts are not being passed on to the ultimate consumer, we will take up the issue with the industry bodies. There will be intervention if we find that some segment of the industry is not passing on the benefits.
And you know, once such things find traction, they cannot go unnoticed, because society today is so interconnected. If businesses don’t pass on the benefits to consumers, there will be a backlash against their businesses.
Many small businesses, despite the benefits of GST registration, continue to underreport or deliberately avoid scaling up, presumably because they see advantages in staying outside the net. How does the government plan to address this to ensure greater compliance and higher revenues?
There are two issues: businesses not registering for payment of GST, and businesses that are registered but not discharging their liability on their entire turnover. The best way to address this is to make compliance simple.
For that, this reform package includes a simplified registration scheme, recommended by the GST Council and soon to be implemented. This will help retailers, small businesses that mostly issue B2C invoices to end consumers, with only a few B2B invoices in cases like returns to suppliers. Similarly, service providers such as fitness centres or beauty parlours, where the rate was earlier 18% and has now been cut to 5%, will also benefit. All these changes will nudge small businesses to take registration and comply.
Because, ultimately, it is better to make the process simple—easy registration, simple return filing, faster refunds—than to catch businesses later and raise demands.
A very important proposal, which has received in-principle approval from the GST Council, relates to e-commerce. Today, most businesses want to operate through e-commerce platforms. If they make supplies within the state, even below the exemption threshold, they can do so. But if they make inter-state supplies—for example, from Madhya Pradesh to Gujarat—they are required to register, even if they are very small businesses.
There is no problem if they are willing to take registration. But suppose their goods are stored in Gujarat by the e-commerce operator for supplies within Gujarat. At present, they need to set up an office in Gujarat to obtain registration, which small businesses cannot afford. Now, the Council has given in-principle approval to create a simplified registration process for such businesses selling through e-commerce operators in other states. The modalities will be worked out, and once launched, it will be a very big booster for small businesses.
What happens to the valid cess credit that auto dealers hold? Under present rules, they can’t use this credit once the cess is gone.
The ITC (input tax credit) taken on compensation cess can be utilized only for the payment of compensation cess. If there is no compensation cess from 22nd September onwards, the balance will simply remain lying in the books. It cannot be utilized.
They argue that this would affect their cash-flow.
This is not the only time such a situation has arisen. In the past also, whenever any levy was abolished, the credits lying in the books remained there.
Are we now officially moving away from treating tariffs as a revenue source in view of our trade requirements?
You see, customs tariffs are basically not levied for the purpose of revenue collection. Of course, they do generate revenue, but the main idea is to provide protection against the disabilities faced by businesses in a particular region. For example, interest costs may be higher in India, or land and electricity costs may be higher for setting up a business. These are the disabilities. To provide industry with a level playing field and to counter these disadvantages, customs tariffs are prescribed. That is the main purpose. Revenue presently is not the purpose.
But in the past, the Finance Ministry has often raised concerns about the revenue implications of tariff reductions.
I can’t say about the past, but presently that is not the approach. I don’t know what the thinking was earlier, but today it is different. If, in the interest of the country, duties have to be lowered, we don’t go by how much the revenue implication will be.
There’s a view that tariffs should not be kept high, not because of external pressure, but because it is in our own interest to remain competitive globally. Do you agree with that line of thinking?
We should not increase tariffs unnecessarily, because tariffs have to be calibrated very finely. If we increase them more than required, it brings inefficiencies in domestic industry. Then our industries cannot compete in the international market, and they will not be in a position to export.
So, tariffs should be calibrated as per the needs of industry. Our focus should be on addressing the cost disadvantages faced by industry compared to other countries, rather than keeping tariffs high.
For example, if industrial land is to be provided for setting up industries, it should be used for that purpose only, not for making money through resale. The purpose is to facilitate the setting up of industry, and it should remain so.
