A legislative ceiling on the indirect tax rate will curb the tendency of future governments to quietly raise rates.

The nationwide rollout of a Goods and Services Tax (GST) will be the most radical reform of indirect taxes in modern India. Currently, when a good is produced and leaves the factory, it attracts excise duty, which is paid to the Central government. When it is later sold to the customer or middleman, it attracts additional sales tax, which is paid separately to the state government.

If instead, a service is sold (like IT or a manicure or a restaurant meal), it attracts a service tax, payable only to the Central government. Excise duty rate is about 14%, states’ sales tax (also called VAT) is about 12%, and services tax (including Swachch Bharat cess) is about 15%. There are sundry other indirect taxes too, including the notorious (and now mostly defunct) octroi tax.

All of these taxes will go, and will be replaced by one uniform GST all over the country. This means that all states will surrender their right to impose sales tax on goods, and the Centre will give up its right to impose excise and service tax.

This grand bargain of GST has taken 15 years to reach a consensus. GST will bring many benefits to the economy, including raising incomes, efficiency, and eventually reducing prices of goods and services.

Since GST is such a fundamental change, it requires the passage of a Constitution Amendment Bill, requiring two-third majority in both Houses of Parliament. It was passed by the Lok Sabha last year, since the BJP and its allies could comfortably reach the required majority. It is now stuck in Rajya Sabha where it needs 164 out of 245 votes.

The Congress party has 60 votes and it was also the original proponent of the GST Bill. But it has put three conditions, of which two seem to have been agreed upon. The third condition is that GST should have an upper ceiling of 18%. This has become a contentious issue and so far the BJP is opposed to such a limit.

Without going into the politics, here is the reason why a cap on GST rate might make sense. Remember, it is an indirect tax. Which means that it is not related to your income or wealth. Rich or poor, pay the same 15% tax on a dosa or electricity or a cell phone. Naturally, as a proportion of their income, it pinches the poor more than the rich. Thus, indirect taxes are inherently regressive, and if left unchecked, can be terribly unfair.

India like other nations, has tried to steadily increase its share of direct tax collection, but without too much success. Today 65% of all taxes come from regressive indirect taxes, and only 35% from direct taxes. The ratio for most developed countries is exactly the reverse. Only 4% of India’s population pays income tax, but 100% pays some indirect tax (whether on soap, toothpaste or a dosa).

We should be trying very hard to expand the direct tax net (for example by using Aadhaar and PAN to track transactions). Instead, we choose to keep increasing indirect tax rates. Witness the new Swachch Bharat cess, the Krishi Kalyan cess, and dozen times increase in petrol excise duty over the past year-and-a-half.

It is simply too easy and tempting for cashstarved governments to tweak indirect taxes upward and silently pickpocket a billion Indians, instead of going after income earners. Hence, an upper limit hardwired into the legislation will curb the tendency to increase GST rates in the future. The country needs higher tax collection, but not from indirect taxes.

And lastly, there is a precedent of putting a numerical cap on government’s fiscal independence. Remember the Fiscal Responsibility Bill, which put an upper cap of 3% on the fiscal deficit? So also we should learn to live with an upper cap on GST rate.

This article was originally published on Mumbai Mirror here. It has been reproduced with the permission of the author.

For more interesting stories, follow The Curious Economist on Facebook and Instagram.