By Chinmaya Goyal
Chinmaya Goyal is an Economist and Officer on Special Duty at the NITI Aayog.
The Goods and Services Tax was introduced four months ago as a big-bang reform that will transform the Indian economy. What has been its impact, and will it eventually fulfill the country’s expectations? How should the GST Council respond to the unfolding situation?
Initial Period Of Disruption For Businesses
Predictably, GST has set off an initial period of disruption for the businesses. Small and medium enterprises have encountered difficulties with the new tax. Gaps in GST returns filings remain, and the government has been deferring the filing deadlines. Partly, this is a result of glitches in the IT portal and the high compliance requirements set out in the law. Even though the idea behind the invoices matching system to input tax credits is sound, as it helps tackle tax evasion and frauds, it has proven to be a big hurdle to cross every month for many less-tech savvy Indian businesses.
Based on the practical problems of businesses, the GST Council and the government have been proactively taking remedial actions. For example, the GST Council on 6th October approved many measures to reduce the compliance burden on small and medium enterprises. Additional measures are expected in the November 10 meeting.
Even so, given the required smoothening of the information technology system, policy changes and need for businesses to get familiar with the new system, the process of stabilisation may take up to a year from the launch.
Minimal Initial Impact on Consumers
As of now, the government has been successful in minimising the impact of GST on consumers. Being a broad-based consumption tax, GST can lead to large initial increases in retail prices.
Global experience illustrates this. Several countries have faced higher inflation in the immediate quarter in which GST is implemented (see chart below) which lasted atleast for a year.In some countries such as Australia, the prices started rising even before, in anticipation to GST. In the year of introduction of GST, inflation increased to 4.5 percent in Australia (compared to prevailing 1.5 percent), and 5.6 percent in Canada and as much as 18 percent in New Zealand!
In contrast, India has not experienced surge in inflation till now: the CPI and WPI inflation have been well under control at 3.3 percent and 2.6 percent respectively in September.
GST exemption given to mass consumption goods and setting of GST rates close to combined excise duty and state VAT/sales tax rates has certainly helped. RBI estimates that only in 5 out of 21 item groups covered in CPI, higher GST rate relative to previous taxes can increase price by more than 1 percent. But for prices to actually remain stable, it is necessary that firms pass-through of benefit of input tax credit to consumers. Broadly this seems to be occurring as the average post-GST increase in prices of 18 commodities has been merely 0.8 percent. Even for commodities where price rise has been high, the effect is likely to be transitory, as was for countries.
Thus, the initial impact of GST has been mixed: some difficulties for businesses but relative calm for consumers.
GST Will Lead to Higher Growth in Medium Term
What will be the GST’s impact in a longer time frame? The initial euphoria of GST has been replaced in some quarters by doubts on whether it will stimulate growth in the way as was believed. Critics have been arguing that Indian GST is more complex than GST in other countries because of multiple rate slabs and granular assignment of goods and services to them.
Even if not perfect, GST does embed many fundamental reforms elements that are important in raising economic efficiency. For example, by unifying the tax systems in different states, GST has dismantled barriers to inter-state trading, and thus helped in creating a national unified market. This will free up businesses to expand, and become more efficient. Similarly, many cascading taxes have been eliminated that used to distort firms decisions regarding input use.
This will result in better cost efficiency and competitiveness even if the current GST rates have been kept high to cover for government’s revenue loss.
These are not trivial issues. For example, a paper by U.S. Federal Reserve economists estimates that India’s real GDP will increase by 4.2 percent from GST in the long-run even with the 4-slab rate structure. Whether or not the actual growth is as much, GST’s impact will still be profound, especially in Indian manufacturing and export sectors.
The Road Ahead
The challenge for the government will be to address the immediate issues being faced by the businesses, without diluting the prospects of medium-term economic growth from GST.
There may be a temptation to reduce GST rates for small businesses to provide immediate relief. However, the design of such cuts should be made with sufficient caution. Unless they are part of a plan to rationalise the overall structure, there is a risk of further complicating the rate classification of goods and services, exacerbating the real issue of high compliance requirements. Creating a differentiated rate structure across small and large businesses shall end up distorting the incentives for small businesses to increase their scale of operation, which is clearly not desirable. Finally, to provide rate cuts while protecting revenues, the government may end up restricting the seamless flow of input tax credit, which may prove counterproductive.
Two areas on which the government could work on are as follows:
The government could simplify the classification of goods and services to different rate slabs such that functionally similar items fall into a single tax slab. This will avoid confusion and ease compliance.
The invoice-matching system also needs to be re-examined and potential alternatives should be explored. This could include retaining invoice-matching only for high-risk transactions, and using data-analytics to unearth cases of mismatch in returns of suppliers and buyers.
Close co-operation and communication between the government and business community will help navigate the immediate challenges in GST implementation. Over time, growth opportunities will emerge, especially in manufacturing and exports. There is no doubt that GST will be a catalyst towards transformational change in the Indian economy.
Featured image credits: Ministry of Finance and Corporate Affairs