Goods & Services Tax- the Macro Perspective
Mr. Sujit Kumar
Economist and Banker
The GST was an idea whose time had come. India had decisively embraced market led economy with 1991 reforms unleashing the competitive spirits through liberalization, privatization and globalization. Subsequent governments furthered the scale and scope of reforms as India fast integrated with global economy. The trade in goods & services with rest of world zoomed while finance capital moved in/out international borders more easily. However, India still had to wait couple of decades before citizens could enjoy similar ease of doing business internally, particularly across the state borders. The long queues of trucks at state border check-posts mockingly reminded India’s dirigiste past, wherein petty corruption ruled the roads at the expense of state exchequer. The GST was envisaged as answer to that quest of economic freedom.
The evolution of GST is also a story of India’s deepening federal character, wherein the centre and states, while respecting their constitutional rights & responsibilities have shown flexibility to build better synergies. The GST Act witnessed a rare consensus in India’s fractious and noisy politics, ushering a new era of cooperative federalism. It bodes well for largest democracy in the world.
While there exists a larger consensus on the GST being good for India’s economic future, doubts persist on the degree of benefits that will accrue. There are also questions about the manner of it being rolled out, the adequacy of infrastructure as well as preparedness of citizens at large. Encouragingly, Government has shown receptiveness to stakeholders’ interest, amending rules to make the transition smoother. More skepticism prevails about the distributional/equity consequences of GST— between Government at Centre and states, between producing states and consuming states, between business and consumers, and of course, between poor and rich. These are genuine concerns and have macroeconomic implications. It calls for deeper analysis.
The present article, however, is limited in its scope; analyzing the GST impact on macro-fundamentals— income growth, price situation, interest rate policy, fiscal dynamics and international balances, from a near to medium term perspective.
The GST Impact on Macro Fundamentals
To begin with, the biggest and loudest criticism of GST has come from the price perspective. Critics have referred to international experience of Australia, Canada, Japan, etc, which noted generalized price pressures in immediate aftermath of GST adoption. However, it need not happen in India as almost two-third of consumer price index (CPI) basket is either tax exempt (e.g., food items, housing) or taxed at lower rate bucket (e.g. most mass consumption goods) under the GST. For certain services like health, education, transportation, etc., which make around a third of personal consumption basket, there will be level shift effect on prices. These fall under 18 percent GST rate bracket as against 15 percent earlier. Its inflationary effect should peter-out by next year, however. This could mean neutral to downside bias for general price level in economy.
The GST helps in reducing the cascading effect of tax on the cost of goods and services, thus lowering the prices paid by ultimate consumer. The Government need to be watchful however, as there could be instances of profiteering, which is to say, producers or intermediaries not passing-on tax benefits into retail prices. In near term, they may raise the mark-up on the cost of production, thereby thickening the profit margins.
From interest rate policy perspective, price developments call for a wait & watch approach from the Reserve Bank of India. As the new taxation regime settles in, with stake-holders getting used to new way of business, the price pressures will come down reflecting improved efficiencies in value chain, and lowering of transportation costs, in general. The GST will set the stage for lowering of interest rates in future.
The GST will be revenue accretive for Government as it will help expand the tax base. Its impact will be most visible in India’s informal economy, dotted by micro, small & medium enterprises (MSMEs), most of which either willfully opted out of tax-net or under-reported income, thus evading due taxes. Moreover, it will also help lowering the tax administration costs as the input tax claim provision under the GST will inculcate peer-compliance by businesses. Therefore, GST should be net positive for fiscal position of government.
The GST structure follows the destination principle. Accordingly, imports are subject to GST, while exports are zero-rated, which means no tax is payable on the exports but Input Tax Credit/ Refund benefits is allowed. It will help producers avoid cascading effect on inputs, thereby making exports competitive. Moreover, the GST regime is investor friendly by lowering the number of taxes and downsizing the layers of bureaucracy. It will help spur foreign direct investments (FDI) into Indian businesses. Thus, there will be net positive impact on external balances.
The analysis above equips us to assess the GST impact on output and employment in economy. There are three channels through which GST will influence aggregate demand, and thus employment in economy.
Firstly, by enhancing the production efficiency, which will be most manifest in rationalizing logistics expenses of companies. In earlier system, to save on taxes, manufacturing firms would often set-up their ware-houses in distant geographies, across states. This however, meant increase in transportation costs as the inventories need to be brought to markets for sales to happen. The transporting truckers had to navigate a complex web of barriers, variety of tolls, from legal to outright bribes. It, in effect, would prolong the transportation time. It also encouraged collusion among transacting parties, thus understating the movement of goods to evade taxes. The biggest victim of all this was agriculture, wherein the perishable nature of supplies meant unusually high costs of confrontation with authorities. It also exerted avoidable volatility in farm prices. The early reports affirm huge savings in transportation time (down 30 percents).
Secondly, by expediting formalization of economy. The GST entails a digital compliance culture, as all transactions gets reported at one stage or other. The dual authentication of invoices will reinforce tax compliance as the digital trails equip tax authorities to target those playing mischief. The GST should also force a behavior shift in employers, particularly MSMEs who understate employee base to avoid breaching tax thresholds. This will help broaden the social security benefits for employees. Moreover, the upcoming e-way bill provision under GST would require any good more than Rs 50,000 in value to be pre-registered online before being transported. Equipped with the precise information, tax authorities can do physical verification of conveyances, thus fostering tax compliance.
Thirdly, income effects of lower effective tax rates and prices in general. As GST spurs tax buoyancy, the Government will re-visit the rate threshold, setting it progressively lower. International experience tells that GST does expand the tax base, and thereby revenue mobilization. A lower tax rate means there will more disposable income in hands of consumers. Further, if price effects, as analyzed above, also lead to cooling of price level, the real income of consumers will rise. Meanwhile, a softer interest rate regime will further investments. Cumulatively, these effects could raise the aggregate demand in economy.
To sum up,
The GST we have in India may not be the ideal one, viz. singular rate and universal in scope. It is no panacea for all the problems facing economy, and businesses in particular. However, it marks an important advance in our reforms journey unleashing the productive potential of economy. It is a more efficient tax system, largely neutral in application and distributionally attractive which should help broaden tax base, enable lowering of tax rates, and reduce compliance costs for businesses. Macro verdict, as analyzed above, is largely neutral in near term to definite positive in long term. Whether the GST delivers the intended benefits will depend on how smooth and holistically it gets implemented.
1) GST is a value added tax on consumption of goods and services, levied at all stages of value chain with credit of taxes paid at earlier stages available as setoff. Thus, only value addition will be taxed and burden of tax to borne by final consumer.
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Mr. Sujit Kumar, | Economist and Banker |
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