The Goods and Service Tax regime was introduced to the citizens of India in July 2017. The Senate had to ensure that the revenue of the Central and State Governments are not compromised/reduced because of the new tax structure. It was a known fact that the revenue of the Government would not be the same in comparison with the then-existing tax structure due to the enhanced tax credit mechanism and other modifications. Therefore, an adjustment in the tax rate was required to avoid a reduction in the revenue of the Government.
To ensure that the revenue does not reduce, an adjustment in the tax rate was required. This rate was termed as the ‘Revenue Neutral Rate’ (RNR). In other words, RNR is the rate at which tax revenue remains the same despite giving credit of duty paid on inputs and other factors. It is the rate of tax that allows the Government to receive the same amount of money despite changes in the tax laws.
The essence of calculating the RNR is highlighted in the simple equation:
- t stands for the RNR;
- R is equal to revenues (both Centre and state) generated from existing sales and excise taxes, which will be replaced by the GST and
- B stands for the total tax base required for generating the required GST revenues.
Note: Basically, the RNR exercise attempts to calculate B,
As per the recommendations from the Subramanian committee, RNR can be calculated with 3 different approaches:
The Macro approach makes use of the national income accounts data and supply-use tables to arrive at base B. It uses the following formula:
𝐵 = ∑(𝑌 + 𝑀 − 𝑋) − [(1 − 𝑒)∑(𝑁 + 𝐼)]
- B is the potential GST base;
- Y is the domestic output;
- (M-X) is net imports (imports minus exports);
- (N+I) is the consumption of intermediate and capital inputs;
- e is the exempt output ratio (i.e. the tax base associated with inputs used in the production of final exempt consumption); and
Note: The summation is over 140 goods and services and 66 sectors, based on the 2011-12 national accounts.
The following assumptions were made for this formula:
- Full compliance;
- Full pass-through of the GST into prices;
- No behavioural response;
- The GST has a single positive rate, and
- A zero rate on exports.
Under the approach, the RNR was found to be 11.6% after factoring the compliance of GST at 80%.
Indirect Tax Turnover (ITT) Approach
This approach estimates the base in a three-step process.
- First, it estimates the base of the goods at the level of the States. This base is estimated by converting data on actual collections and statutory rates into a goods base. In other words, the effective rate becomes the basis for the estimation of the goods base. In the absence of data for all the States, the key assumption is that States collect revenues at three rates (1 percent, 6 percent, and 14 per cent) in such a proportion to yield a total taxable base of INR 30.8 lakh crores.
- In the second stage, the services base is estimated based on turnover data of 3.25 lakh firms from the newly available MCA database (this base is estimated at INR 40.8 lakh crores).
- In a third stage, adjustments are made to this base to remove IT-related services because a large part of them are exported, and to remove most of the real estate and financial services from the base because of the manner in which these items will be treated under GST. This adjusted base is then subject to an input-output analysis to deduct from the base taxable inputs used for the provision of service and also deduct services used as inputs into taxable manufacturing. All these adjustments result in an incremental services base (incremental to whatever has already been incorporated in goods) of INR 8.5 lakh crores and a combined base (goods and services) of INR 39.4 lakh crores.
This base, in turn, yields a single RNR of 17.69 per cent under the scenario of having to compensate the States for the 2 percent CST.
Direct Tax Turnover (DTT) Approach
Under this approach, the income tax data which is available for about 94.3 lakh registered entities (including companies, partnerships, and proprietorships but not charitable organizations) is used. The data is classified into 10 sectors and 75 sub-sectors to calculate the potential base for GST. Unlike the indirect tax turnover approach but like the macro approach, this approach yields a combined base for goods and services, rather than separating bases for goods and services.
This approach yields a combined RNR of 11.98 per cent.
The estimated RNR of the three approaches for estimating RNR are summarised herein below:
(in lakh crore INR)