CM – What four years of GST have taught us

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There is still a long way to go to keep his promise, even though many of his myths have been shattered

When goods and services tax (GST) was introduced on July 1, 2017, it was an achievement. There had been a lot of political bickering and it was a daunting task to get to the heart of it. The idea was for India to adopt this new tax system and refine it over time. What about four years later?

When GST talks were in progress, there were two different views. The establishment-backed view suggested that gross domestic product (GDP) growth would increase by 1-2 percentage points, inflation would decrease and government revenues would increase. However, it rarely happens that everyone is better and no one is worse. On the other end, skeptics argued that a GST system with five tariffs was hardly a worthwhile regime. In addition, micro, small and medium-sized enterprises (MSMEs) would have serious problems with taxes, refunds, set-offs and fines. So it made little sense. There was political noise on the compensation side of the states in the event of deficits, and assurances were made that payments would be made from the outflow buffer created for this purpose if the state revenue did not increase by 14% annually.

Let’s see how things turned out. Two adjustments made by the government were the introduction of a « composition scheme » for MSMEs and the change in the GST rates for various raw materials after making representations. The rule of thumb for success turned out to be 1 trillion monthly GST sales. Since the GST is a consumption-based tax, the economy has to keep going and people have to spend money to make it work.

The turning point in history began in 2017-18 when GDP growth slowed. From 8.3% in 2016-17, it declined to 4% in 2019-20, before turning negative in 2020-21 with an 8% drop in production. As a result, the GST survey base in India has narrowed relatively, which has left a mystery. In relation to GDP, the GST surveys were 6.9% in 2018-19, which decreased to 6.6% in 2019-20 and 5.8% in 2020-21. That part of the story obviously didn’t work.

The greatest challenge for the GST regime concerns the compensation of the states. The states want to check this, as the growth-related compensation of 14% should last five years and with only one year it still seems to be on slippery ground. Due to lockdowns in 2020 and again in 2021, people couldn’t spend much. This has had an impact on revenue. When GST compensation was first discussed, it could not be assumed that all states would have to pay for deficits at the same time. It is worth remembering that neither the States nor the Center wanted to borrow to fill this gap in FY21, and the latter eventually had to give way and go to market. This issue needs to be addressed as such a situation could recur and the provision may need to be extended for an additional five years.

The second challenge concerns exclusions. The government had kept fuel and « sinful goods » out of the GST’s reach so that it could maintain control of this lever to raise interest rates and generate revenue. This has to change because an unintended consequence has been higher inflation like the one we see today. It is quite absurd that from the retail price of 100-105 yen per liter of gasoline, a little more than 60 yen is taxable. The problem is that its price is being influenced by the global price of crude oil, which is now testing $ 75 a barrel. Add to this taxes in the form of excise duties (₹ 33 per liter) and VAT (30% in Delhi) and the consumer is faced with high pump prices. Lockdowns result in lower fuel consumption and lower government revenues. The solution was to increase these taxes to protect revenue. GST excise levies had decreased to 2.3 trillion yen but rose to 3.7 trillion yen in 2020-21.

The secondary effects of higher fuel costs are via the transport route, as the prices of all raw materials rise once transport costs are taken into account. Gasoline and diesel together have a weight of 2.3% in the consumer price index. This may seem small. The knock-on effect, however, is strong as it leads to higher prices for grain and finished goods. Because of this, retail inflation has been higher than it should be and the role of non-GST fuel is very important.

The third challenge is to meet our need for a single tariff for all goods. Otherwise the GST is similar to the complex previous regime, with the exception of the subsumption of state taxes. The past four years have given us an understanding of how goods should be taxed and what revenue will go to the government. There is now an urgent need to reduce multiple tariffs in a single slab.

Our four years of experience also shattered some tax myths. GDP growth only increases when more income is spent, which is best achieved by creating more jobs. The GST itself cannot increase GDP, although statistically it can include the disorganized sector to a certain extent and should not be confused with a growth engine. Second, given deep contradictions in our tax structure, inflation will remain out of the reach of the GST. Third, the economy needs a boost so that government revenues can rise. With our current low growth syndrome, we cannot expect miracles. These are the GST revealed facts.

Madan Sabnavis is the chief economist at CARE Ratings and the author of « Hits & Misses: The Indian Banking Story ». These are the author’s personal views.

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