The fate of the compensation cess

In our piece yesterday, we reviewed the performance of the Goods and Services Tax (GST) over the past seven years, emphasising that the states did well but at the cost of a revenue sacrifice by the Centre.

- VARUN AGARWAL, JOSH FELMAN, THEERDHA SARA REJI & ARVIND SUBRAMANIAN

In this piece, we look ahead to consider the fate of the compensation cess.

This cess is due to be reviewed over the coming year because it has now lost its major rationale, which was to fund the temporary revenue guarantee that the Centre had provided to the states- a guarantee that has now expired. Accordingly, the GST Council's review will need to answer two important questions. First, what should be done with the cess? Second, should the revenue guarantee be revived?

With respect to the first question, some have proposed that the cess be eliminated on the grounds that such an action could boost consumption growth. But it's a long-standing principle that tax rates should not be dictated by short-term cyclical considerations. It is true that consumption growth has been quite weak in recent quarters. But perhaps next year it could prove quite strong. Would anyone then recommend raising GST rates? We think not.

Instead, GST rates should be set according to longer-term considerations. Foremost among these is the consideration that some goods are "demerit goods", which should be taxed more heavily to discourage their consumption. In India, these demerit goods include tobacco, aerated drinks, and motor vehicles. So, for example, a cess of 2-22 per cent has been levied on top of the 28 per cent GST rate for motor vehicles.