A workable solution: Sharp rate hikes not inevitable to bridge GST revenue gaps

Most commentators on public finance including the RBI and 15th Finance Commission have been concerned about the GST debuting with a rate structure that was marginally below a computed revenue neutral rate #RNR for a quantified base and then slipping considerably below that level.

There have been multiple rate reductions over the years as economic stimulus. So the most prominent strand of a plan to insulate the state governments from the shock caused by the withdrawal of the guaranteed State-GST revenue is to promptly restore the RNR.

This is also expected to improve the aggregate revenue buoyancy. However, there needs to be a careful reconsideration of this strategy that involves wholesale rate hikes, for two reasons.

Firstly, revenue buoyancy is not just a function of tax rate or the incidence of tax on any economic agent. After a threshold, the two have an inverse relationship and this dividing line also alters in response to the consumption-demand scenarios or price elasticity of demand.

Secondly, RNR is not a constant, rather it’s constantly prone to the changes in the consumption matrix.