Why goods and services tax is no magic

Miracles may happen, yet recent economic history doesn’t have enough evidence to support the perception that an economy can quickly obtain a high growth trajectory simply by altering its indirect tax structure. But we have been convinced by the NDA government in last few months, that once the goods and services tax (GST) is put into operation, the growth rate will go on a gallop. It must be stated that the BJP started seeing a panacea for weak growth in the GST only after coming to power. Before that it was taken only as a tax reform measure and BJP was strongly opposed to a rush on the issue.

As the ruling dispensation concedes the fact that a quick roll-out of a full-fledged GST seems complicated, enthusiastic investors and experts have also started coming to terms with the reality that GST’s "magical" properties as a driver of growth were grossly overestimated. While the government is pushing the idea of a central goods and services tax (CGST) to meet the April 1, 2016 deadline, it makes sense for us to get cognisant of the facts and edit our unrealistic aspirations on the GST.

For instance, we must pause for a moment before buying the hype that no sooner the GST is implemented the economy will grow at a one-two per cent higher rate. According to the International Monetary Fund (IMF), as cited by Ambit Capital in a report, there is no direct relationship between indirect tax reform and economic growth.

Between 1986 and 2000, GST was implemented in four countries. New Zealand adopted GST in 1986 and increased its rate in 1989. It came to Australia in 2000, while it was adopted by Canada in 1991, which revised its rate in 2006 and 2008. Thailand introduced a comprehensive, all-inclusive GST in 1991. Following its introduction in these four countries, growth rate spurred only in New Zealand, while it slumped in the rest. Experts say that GST just happened to be one of the factors that contributed to growth in New Zealand. It was not the sole or significant contributor.

That being the case, from where did this calculation of two per cent rise in the GDP come from? In fact, the National Council of Applied Economic Research (NCAER) had produced a report in 2009 that said that better growth could be expected if an ideal and modern GST was introduced in India. But the GST that would come now will have a five-level tax system. There will be central taxes under CGST (excise, service), state taxes under SGST, IGST (instead of central sales tax) on inter-state sales, and one per cent additional tax on inter-state supplies, besides a separate tax on petrol, diesel and aviation fuel. The logic of growth slumps owing to this five-storey GST.

As the GST eliminates double and triple taxation, its role in reducing price rise is established. After its introduction in Australia, Canada, Thailand and New Zealand, inflation was curbed. But in India, the greatest uncertainty on the GST is regarding this aspect alone. The GST rate, in the countries where it has been introduced recently, varies from five (Japan) to 19.5 per cent (European Union). GST is pegged at a revenue-neutral rate (RNR), which means a rate at which the government does not have to incur revenue losses. For India, it has been calculated to be 18 per cent, where it will not increase revenue, but will not reduce revenue either.

In India the average indirect tax rate is 24 per cent. That is why the GST rate is likely to be higher than that as governments need increased revenue to meet their growing expenses. The Ambit study shows that there will be a one-two per cent increase in the tax-GDP ratio if the GST rate is 25 per cent. The government will get higher revenue which they can spend on development. However, a 25 per cent GDP will aggravate inflation and could depress demand.

There are practical complications on the GST besides implementation issues. These should be explained to the masses in a transparent manner. For instance, if the GST rate is fixed at 18 per cent, certain items like cars, consumer goods and building materials may become cheaper, but if it is as high as 25 per cent, prices of a majority of goods and services will scale a new high. In India, telephone, education, hotel and dozens of different services constitute a large part of people’s spending. The GST will hurt in several ways as far as services are concerned. If the GST rate is fixed at 18 percent the effective rate of tax on services will rise 18 per cent from the existing level of 14 per cent. However, services will get dearer if the GST rate is fixed at 25 per cent or above.

Hopes from economic reform are justified, but building castles in the air can fling you to earth face down. Every economic reform brings its benefits and shocks. The government’s desperation to put its signature on a slate of reforms is obvious, but presenting sensitive, multi-dimensional and complex issues as elements of a magical trick before the people is not at all a wise strategy.

It is difficult to understand why the debate on GST cannot be brought out of political circles to the producers, traders and consumers, who have to implement, collect and pay it. Instead of creating hype over the GST, it is important to have a well-informed debate on the issue to keep taxpayers prepared for the inevitable bumps, jolts and U-turns on the road to GST.