Let’s Not Jump the Gun Over the Impact of GST

The passage of the GST bill through the Rajya Sabha will be a political, and not economic, success. The real task of implementing it still awaits us.

A labourer loading a goods truck. Credit: Reuters

A labourer loading a goods truck in Maharashtra. . Credit: Reuters

GST is the next big thing, with progress hopefully expected this week, which will bring about a transformation in the way the system works. There have been several papers telling us that this will be beneficial as growth will be enhanced besides reducing the time and effort taken in complying with the existing tax structures. The current impasse is supposedly due to the disagreement on the GST rate as well as the compensation structure for the states which may be losing out on revenue once this tax is imposed. The real reason however for the delay is more political, which has now become a habit. How crucial is it for us?

The GST is a system of a single tax rate on all goods which subsumes the rates imposed hitherto individually by various levels of the government. The federal structure of our government had bestowed various powers to different levels of governments which had the effect of creating a very complex and high cost structure. Besides compliance with the plethora of taxes presently means going to various windows to pay the dues which imposes a high cost on companies. Further, as governance levels are low in this area, it has led to high levels of corruption.  A single tax rate which is transparent to all would make things easier.

The biggest beneficiary will be the business community as it will find it easier now to pay these taxes and will be freed from horrendous red tape. This is hence an efficiency enhancer which will help them operate smoothly with less scope for dispute across tax windows which is the case today. This has been stated to be successful in all countries which have pursued this reform; and whenever there are different layers of governments with separate powers for taxation, the benefits of a GST would tend to be larger.

However, if we have to go beyond this efficiency impact, one has to tread carefully in conjecturing the impact as there are several issues that have to be addressed once the bill is passed. In the past too it has been noticed that there is a lot of noise for a particular ‘government action’ or a specific policy but once it is done,  realisation hits that there is not much of a change in the overall working environment. Take for instance the famous stalled projects story where government inaction had led to various projects coming to a halt. Both the UPA and NDA governments have cleared several projects amounting to over Rs 6 lakh crore, but the investment rate still continues to fall. The reason is evidently that the other factors that should be in play but have not been operational such as market conditions, other reforms etc. Intuitively it seems that clearance was not the major issue for this situation and has been used as a justification for the build-up of the same. Therefore, care must be taken in forming expectations of any such reform as often we tend to go overboard here. Also when there is a limited impact, we often forget the issue.

First a lot has been spoken on GST increasing growth in GDP and various studies talk of this enhancement by 1-2%. Are we really saying that with GST coming in FY17, GDP growth will move from 7.6% to 8.6-9.6% in say the next couple of years purely on this score? To answer this question, the explanatory chain needs to be understood. India is a country where supply meets demand and there are few cases where demand has not been satiated. Therefore, GDP growth has not been affected by supply not keeping pace with demand. In such a situation the existing tax system can make the production processes inefficient by perpetrating a high cost economy, but cannot be a limiting factor for production as high costs are passed on to the consumer. Therefore, unless prices come down drastically, only then can we talk of higher demand which will push up GDP growth. The critical factor here is hence prices.

Better compliance

At another level it is argued that a GST will lead to better compliance as several SMEs that were not paying taxes on account of these complexities will find it worthwhile to do so now. There is some strength in this argument, though this will be a one-time effect provided the value added is higher than the imputations that are being made by the CSO. Also at times the units may be hesitant to pay up for fear of being tracked for their past tax history.

Secondly, will inflation go up or down? The government has spoken of a revenue neutral rate with a neutral inflation bias. Is this possible? The rate being spoken of is around 18% which means that all goods and services would be taxed at this rate. Services will end up being significantly more expensive and hence has to be compensated by lower prices of manufactured goods. But it has been observed that even when the indirect rates of manufactured goods are lowered, the consumer price does tend to be sticky in the downward direction and the final impact is minimal as producers often push up the basic price when tax rates come down thus leaving the final prices unchanged. The thinking is that once one is used to paying Rs. 80 for a tube of toothpaste, there is no reason to lower the price significantly. Therefore, the inflationary impact is still nebulous.

Third, the tax rate is critical as it impacts the finances of the Centre and states. While this has been worked out at the theoretical level, there would be leads and lags in reconciling them across governments which will cause considerable distortions in the revenue. This can upset capex plans of states in particular when they are not sure of how the compensation takes place and whether the full loss is covered. While this would normally be a mathematical exercise given the fiscal constraint that they have to adhere to at 3% fiscal deficit ratio, they would have to be conservative when it comes to dealing with capital outlays lest they digress. The Centre may have to have a ‘forgiveness’ fiscal deficit of say 0.5% of GSDP just as has been done for the UDAY scheme to reduce the noise factor here.

Chaotic beginning

Fourth, there is the challenge of the systems working smoothly. While it is stated that the nation is ready, the technology platform has to be integrated and be robust so that any payment made can run through the processes of adjustments through VAT, apportioning to states and retention by the centre in a seamless manner. Related to this issue is the education or awareness that has to be spread so that all parties are aware of the same. This has to be advertised heavily with special programmes being held so that all those in the tax net are cognizant of the system and how they have to go about it. To begin with things may be chaotic.

Fifth is the challenge of surplus staff where we have to answer the question as to what has to be done about it. A GST system which involves the use of a single window to transact will make the other windows irrelevant over a period of time which will mean redundancy of jobs and the redeployment of the same. There will be two aspects to this redundancy. The first is the labour displacement by widespread use of technology which has been witnessed in almost every field. The other is the overlap of functions of personnel at the centre and state levels which will get subsumed.  

What all this indicates is that GST is necessary and should be implemented to make the system more efficient and transparent. However, the benefits beyond the efficiency prism needs to be evaluated with caution and can be gauged only after it is implemented. More importantly, there are several issues which have to be addressed either before the implementation or during the course of the same to ensure that the contradictions that arise along the way are resolved. While on paper the effects are alluring, the final results will be known only after it is implemented. As the federal structure is complex, the distribution across states will take time to resolve and the first charge on this kitty will be important as that can affect the working of the budget of the government- either states or centre.

Hence, while getting it passed in the Rajya Sabha is necessary, it may not be time to celebrate as the real task begins subsequently and the passage of the bill this week will probably be more a success at the political level. This may be a more pragmatic way to look at the GST.

The author is Chief Economist, CARE Ratings. Views expressed in this article are personal.