The GST regime has simplified taxation, brought stability and has been a success, enabling record collections ahead of targets, but there have been constant demands for rationalization of the GST rate structure. The present structure has multiple tax slabs, making compliance and administration complex. Hence experts in the industry have demanded lowering of tax slabs.
The Group of Ministers (“GoM”) recommendation of a new slab with a tax rate of 35% for tobacco products and carbonated or aerated beverage is contrary to the objective of GST rate rationalization, as with this, GST will now have an additional layer of tax slab. It is also being mentioned in sections of the press that apart from proposing changes to the GST rate on tobacco and aerated beverages, the GoM is also deliberating revisions to tax slabs on a range of other goods, including ready-made garments, and luxury items like handbags and watches. The proposed increase in GST is likely to further reduce consumption and demand, impacting economic growth. The logic of pushing GST rates higher especially in an inflationary environment and falling demand does not appear to be prudent.
Impact of proposed increase in GST
Aerated drinks
As per a cross-country World Bank study on sugar-sweetened beverages, India has one of the highest tax rates for carbonated soft drinks at a total tax rate of 40 % as of 2023. Countries like the UK and France have adopted a sugar-layered tax approach, i.e. high sugar/high tax and low sugar/low tax. Growing health consciousness in India has seen consumers switching to lower sugar content products, creating a new market for reformulated aerated beverages. However, a uniform tax on sugar carbonated drinks disincentivises producers from investing and innovating to produce products with low sugar content due to the high tax rate.
A layered tax approach will enable producers to invest in manufacturing these products, leading to more jobs, and consequently more revenues for the government. It will also bolster innovation, promote public health, while increasing revenues for the government. Higher costs would also lead to reduction in the manufacture and consumption of aerated drinks and result in an overall reduction of the government revenues.
Cigarettes
The proposed 35% slab is excessive, as consumers, already reeling under inflation are likely to shift to cheaper products or the grey market. Tax policy that is too aggressive threatens to reverse the positive trends in healthier decision-making.As per the WHO data, cigarettes are least affordable in India due to high taxes basis the per capita income levels. Increase in tax rate will further increase the unaffordability of cigarettes, particularly at a time when disposable incomes are low and the consumers’ capacity to pay is under stress. Consumers will opt for smuggled cigarettes which are sold cheaper due to tax evasion. Excessive taxation on cigarettes over the years has boosted illicit trade at the expense of legal tax paid cigarettes. A surge in the grey market for such products, will be counterintuitive and imported / counterfeit products will be sold without any quality checks and in an unrestricted manner including to minors. This would also lead to loss of potential revenue to the government, besides general public health issues.
Estimates from International research agencies such as Euromonitor, suggest India is now the 4th largest illicit cigarette market in the world. Illicit cigarettes according to the research agency now represent 26.1% of Indian cigarette market, as much as 1/3rd of the legal cigarettes – this will go up significantly
To curb illicit trade– an approach, both in terms of tax moderation and strict enforcement are required. Surely, increasing the tax rate would only help illicit operators make more profits with higher arbitrage. Revenue growth targets may thus not be met.
Balancing growth and inflation
A focus on encouraging compliance with lower tax rates and improved enforcement would be more effective. It will be critical for the government to strike the balance between growth and inflation against the backdrop of geopolitical developments and economic uncertainties. The prevailing economic environment necessitates that the GST Council keeps the consumer and businesses at the heart of its decision-making.
Authored By: Upendra Nath Sharma, Partner, JSA.