India has the dubious distinction of having the highest Goods and Services Tax (GST) rate worldwide, of 28 per cent. Even the 18 per cent GST is comparable with the highest GST rates found anywhere. If we include the different types of cess and other charges, effective tax rates are much higher. However, media reports suggest that India intends to increase the GST rates.

In contrast, Canada imposes a uniform 5 per cent GST on most goods and services. Singapore has a uniform GST of 9 per cent. Bangladesh’s tariff rate is up to 15 per cent. The UK has a uniform tariff of 20 per cent on most goods and services. The UAE imposes a tariff of 5 per cent that encourages Indians to visit Dubai for tourism and shopping.

It is a fallacy that higher tax rates translate into higher tax collections. When taxes go up, consumers respond by reducing demand. High tax rates lead to a fall in demand, job losses, reduced economic growth, and lower tax collections.

India imposes a 28 per cent GST on non-essential goods, such as large televisions, luxury hotels, and air-conditioners. A high tax policy on non-essential goods has failed in several countries and hurt poor people the most.

Ramsey taxation rule

Frank Ramsey, a University of Cambridge economist, derived the Ramsey taxation rule in 1927. He argued that non-essential goods are not needed. Hence the demand for these goods is price sensitive. When a tax increases their price, several people abstain or postpone their plans to purchase such commodities and search for alternatives.

Hence, even a marginal price increase induces a significant drop in demand for such commodities. As the sales plummet, tax collections also go down. Firms reduce production in response to low sales, leading to job losses for unskilled and semi-skilled workers.

The US imposed a 10 per cent tax on luxury goods such as yachts through the Omnibus Budget Reconciliation Act of 1990. Edmund Contoski, an American economist, found that after the first year, one-third of US yacht manufacturing firms stopped production. In the next few years, 25,000 workers lost their jobs building yachts, and 75,000 lost their jobs in allied sectors. The US government repealed the 10 per cent tax on luxury goods in 1993. Luxury hotels in India are taxed at 28 per cent to soak the relatively well-off. However, this policy made Indian tourism destinations expensive and incentivised Indian and foreign tourists to avoid India and explore alternatives such as Vietnam, Thailand, and Sri Lanka. Fewer tourists translated into lower tax revenues and adversely affected the livelihoods of people dependent on tourism.

In India, GST on large televisions is 28 per cent. The increase in price due to high taxes deters several buyers. Low sales lead to low production and job losses for poor and middle-income people. The Clothing Manufacturers Association of India (CMAI) estimates that one lakh people will lose jobs if the government increases the GST on apparel.

The deep structural flaws in the Indian GST system encourage cronyism and discourage small businesses. Most countries with a GST system have single or dual tariffs, but India has multiple tariffs. India’s GST tariff rates are 28, 18, 12, 5, 3, and 0 per cent. The myriad tariffs increase the cost of compliance for small businesses. Besides, GST rates appear to be arbitrarily decided and changed. For instance, a 28 per cent tax on cement substantially increases the cost of construction and makes homes unaffordable. Cement is neither a luxury good nor a harmful commodity like cigarettes.

A high tax on non-essential items impedes people from increasing their productivity and achieving their aspirations. Goods that are necessities today were considered luxuries in the past. For example, mobile phones, cars, and laptops have become necessities and made us more productive.

India should move towards lower GST rates and uniform tariffs.

The writer is Associate Professor of Economics at RV University