Service Tax Rate Hike: The Other Side

The funny thing about a democracy is that there is always room for criticism. All of us manage to squeak in some wit and make scapegoats out of the ‘incorrigible’ politicians and the media. Be pro-business and you are an elitist, suit-boot ki sarkar, release a pro-farmer budget and you are populist and are seeking to woo the farmer vote-bank. The concept of a trade-off is too abstruse for the Indian conscience.

And before I begin, yes, I support the move. But no I’m not a blind bhakt, which is why I’ll explain my stance in the following lines.

SERVICE TAX has been increased by 0.5% to a total of 15% on account of the Krishi Kalyan Cess, applicable w.e.f. 1st June 2016.

The way we think about taxes and economic decisions, in general is very unidimensional. Economics can very well be defined as a science of picking the best alternative out of the given choices. We judge economic policies based on their short-term, direct relationship with ourselves. Therefore, we don’t just benefit when tax rates are lowered but also when they aren’t, but far better things are achieved as a consequence. We benefit equally when our incomes rise or when they don’t, but inflation falls. But through our unidimensional thinking, we would always pick the former over the latter. Consider the following:



One Rank One Pension and the 7th Pay Commission were introduced amid demands by an emotionally charged and furious India. This was the same India that wouldn’t settle for a relaxation in the fiscal deficit target of 3.5%. Both are reasonable and important demands after all. But if you want to maintain the same (revenue-expenditure) and want to increase expenditure, you also have to increase revenue. Income tax slabs weren’t lowered as what people wanted and in fact, corporate taxes were lowered (next point). The one place where the government stepped up its revenue has been the service sector.

Maintaining the fiscal deficit is important to control inflation, allowing room to reduce interest rates and reducing the government’s borrowing needs which leads to unnecessary revenue expenditures (interest payments).

Hiking expenditure is important to meet the obligations under OROP and 7th PC but also so that public investments can be made. Right now the only thing driving our economy is private consumption which is in turn driven to a large part by public expenditure. Read This

Bottom Line: We need to raise tax revenues.



Most of us hailed the ‘Make In India’ programme and would agree that getting FDI and corporate investments is the need of the hour. But how do you achieve that? To a large part, by reducing the corporate tax rates. The rates were proposed to be reduced from 30% to 25% in the 2015 Budget over a period of 4 years. In this year’s Budget some steps towards realising this were made with taxation being relaxed for new enterprises/projects.

While this may sound encouraging, this is just one side of it. These rate cuts directly translate to lower tax revenues. To meet this shortfall, we need to increase the taxes somewhere else. The agricultural sector is any way tax exempt, which leaves us with the service sector.

India has had a growth story in terms of the composition of growth which is divergent from the usual trajectory. Our service sector grew much faster than the other sectors of the economy. So today while we are a global behemoth in services (think IT sector, BPOs and hospitality), we still lag behind in manufacturing. It is only fair to burden the sector which has the resilience for the benefit of the sector which is lagging.

Bottom line is that if you want better and cheaper products; if you want exports to grow, CAD to fall; and wages therefore, incomes (yours too) therefore demand therefore production therefore GDP to grow, we need this. Phew. Next time don’t blame the government for slow GDP growth and crib about the rising service tax rates at the same time. (exaggeration; don’t kill me).



By now, I don’t think it would require long sermons to prove that we need the GST ASAP.  Service tax needs to be hiked to facilitate the bringing in of the GST.

With GST, goods and services are to be brought at par in terms of taxation. Therefore, services are to be treated with a higher incidence of tax at par with the net rates for goods. The rates for GST are proposed at around 16-19%. A sudden spike in service tax rates is always seen as inconvenient to all stakeholders. Instead, a gradual increase will allow the service providers and consumers to adjust to the new rates. Also, the GST is likely to produce short-term shortfalls in revenue collections for the government. This again is to be met from increased collections from now onwards. This may sound insignificant, but these have been some of the biggest contentions in the bringing of the GST.

Bottom Line: If you want the smooth and early transition to GST, we need to hike service tax.


However, some riders:

  1. Hiking a proportionate (therefore regressive) tax to ease up a progressive tax i.e. corporate tax, despite its benefits, burdens the poor.
  2. Though corporate tax rates are being lowered, so are the exemptions attached to the corporate tax.
  3. The tax is being collected as a cess -widely understood to be a means of avoiding revenue sharing with the states. Also, India has had a poor record of utilisation of cess money in the past. Certainly a thing that can be corrected, albeit. Read This

I hope this article does enough to highlight the multi-dimensional nature of economics and how decisions cannot be judged in isolation. The Service Tax rates were expected to be increased to 16% and in fact the industry was surprised with the liberal rate hike.


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2 thoughts on “Service Tax Rate Hike: The Other Side

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