Will GST Nudge Up The GDP?

Kavita Rao, professor at the National Institute of Public Finance and Policy (NIPFP) was the author of the think-tank’s paper on the Goods and Services Tax (GST) in November 2008, exactly a year before the Empowered Committee of State Finance Ministers released its first discussion paper on the subject. She is now on the panel on ‘Revenue neutral rates for state GST & Central GST and place of supply rates’ of the state finance ministers’ panel. BW Businessworld sought her out to decipher the nuances of the GST regime.

Excerpts:

Some analysts say that including petroleum products in GST could have given India’s GDP a two per cent boost. Now that the proposal to include fuels within the ambit of the tax has been deferred — would macro-economists hazard a guess on GST’s impact on the GDP?
There have been some studies which suggest that with the introduction of GST, the country’s gross domestic product (GDP) would register a sharp increase in the range of 1.5 per cent to 2 per cent. The only study that I have looked at is the one undertaken by the National Council for Applied Economic Research (NCAER) for the Thirteenth Finance Commission. This study assumes that a comprehensive GST would be implemented. The Bill, however, does not propose a comprehensive GST.

Apart from petroleum products and alcoholic beverages, the proposed GST will also not include electricity and real estate transactions within its ambit. To this extent, one would expect its effect to be somewhat dampened. It is, moreover, not appropriate to expect the impact of the reforms to be instantaneous and large on the GDP.

Would you like to project some numbers on how GST would impact the Indian economy, if the pending Bill is passed by the Rajya Sabha?

The GST could impact the GDP in the following ways:

a) Reduction in cascading (impact of taxes on input costs of production) could result in a reduction in the final price of commodities, which in turn could result in an expansion in demand.

b) Reduction in cascading could result in a reduction in the cost of production, increasing profits for companies — which in turn, could bring in more investment.

c) Reduction in the taxes on inter-state transactions could bring in higher profits and hence, encourage more investment.

d) Better compliance and enforcement may encourage more people to report transactions, which were hitherto not reported. While this would not imply a higher level of activity in the economy, it could transform black money to “white” money.

Each of these channels could take a while to work out, though, before the final impact (of the GST) is evident in the form of a higher GDP. Thus, it would be inappropriate to expect dramatic increases in GDP as an immediately observable impact of the introduction of GST.

What kind of an impact do you see GST having on the inflation rate?
In principle, the GST regime is expected to be revenue neutral, i.e., it should not be generating more revenues than the present regime does. The impact of such a reform on inflation can be broken down into three components:

a) Some sectors which bore more taxes would bear less tax, like manufacturing and sectors like services, which bear less taxes today, would suffer more in the GST regime. By itself, this should not result in more or less inflation, except in as much as the composition of the economy is different from the composition of goods and services in the basket used to compute price indices.

b) In sectors in which taxes could be lower, incentives may not exist to pass on the lower taxes as lower prices. In this scenario, in the short run, the prices of these commodities may not decline, whereas the prices of the commodities or services for which taxes have increased — may increase. This could be seen as a short-term increase in prices. However, with competition among suppliers, the prices (of goods and services) are likely to adjust downwards in due course and inflation too would be corrected downwards. This seems to have been the experience in a number of countries, where inflation was observed in the initial three to six months of introduction of GST/VAT.

Would volatility in crude oil prices and the exchange rate exacerbate the short-term inflationary impact of the tax reforms?
The situation discussed is independent of any increase in the volatility in crude oil prices or in exchange rates. It may be argued that in periods of increased volatility in crude oil prices, introducing a reform such as GST may earn a government a bad name, since any increase in prices could be attributed to the reform. However, the opposite too hold true. With the expanded coverage of media and social media, people seem to be more informed of the impact of global events on the economy and hence, this may be a small and short term concern­— at best.

Will GST be revenue neutral for the Central and State governments — or will there be some gainers and some losers?
The change from the present regime to GST implies a change in the tax base for states. At present states get revenue from central sales tax (CST) in addition to other taxes. But when the new regime is introduced, this source of revenue would be lost, while the states would get an additional base of tax on services. The gains and/or losses for a state would depend on the relative dimensions of the base subject to central sales tax and the base subject to service tax. If these two are in balance, the state would not suffer losses, if not — the state would suffer losses or gains.

For example, a mineral rich state like Jharkhand could be receiving revenues from CST, but its ability to raise a similar amount from taxation of services may not be commensurate with CST.

madhumita@businessworld.in