The passage of the GST on Wednesday is significant as it is one of the major reforms that have been pending which required consensus across various political parties. Also it is a major test for Indian federalism as several Centre-state relationships would be undergoing changes.
The impasse that had built up over the last few months had to be resolved in the Rajya Sabha where the NDA did not have a majority. Now that it has been passed, there would be certain other formalities to be adhered to like most of the state legislatures passing them with 2/3 majority. There will hence be a time lag between today and the time when it is agreed by the mandatory processes. The question is what happens next?
The impact of the passage of this Bill has to be tracked closely as presently all the research and expectations are based on theoretical foundations and it is only when the tax system is implemented that the real impact will be known. On paper there are free flowing charts based on the assumptions of systems being ready, seamless transfer to states, higher growth in GDP, better compliance, zero inflation impact, existence of a revenue neutral rate etc.
Take, for instance, the argument on inflation, which is the worry of the common man that has surprisingly been kept in background so far. Surprisingly none of the states have actually spoken about the inflation impact even though the final rate has not yet been decided which would be finalised by the empowered committee. It looks like that the rate will be around 18 percent, as the principal guiding factor will be that it has to be ‘revenue neutral’ across all levels of governments. All losses for states are to be compensated by the centre in case there are shortfalls.
If we have to maximize a function which is revenue neutral and at the same time keep prices down, it would be a challenge. In fact, the government is talking of revenues actually increasing as more undeclared income comes under the fold of the tax system. The government is to keep out petro products, liquor and tobacco from the ambit which will hence continue to bother the WPI and CPI indices. Further, all services would be coming under the net and also pay a higher rate, which will be more than what is being levied today which is 15 percent. For a services-oriented economy, the impact will be sharp.
There is, however, an argument made that prices of manufactured goods will come down in certain segments. But one will have to follow a ‘wait and watch’ approach here as it has been noticed in the past that a drop in tax rates has rarely been passed on fully to the consumer. And when it has, when for example the excise rate was lowered for the auto sector a couple of years back, prices came down mainly due to the stagnation in the industry where prices were lowered to push up sales.
Further, anecdotal evidence points to a disproportionate fall in prices with producers not fully passing on the benefit. Hence, if the final price of 100 included 80 of cost and 20 of tax, a lowering of tax by say 5 will not lead to price coming to 95, but would be between 95 and 100. Such movements are often justified on grounds of other costs having gone up. Therefore, inflation is something which one has to watch out for.
Second, spreading awareness and keeping all constituents ready for the system is a logistics issue for the government. With a change in the system, the message has to be spread to all with the IT systems in place so that sellers know how to go about paying taxes. The issue gets more challenging when the segment which has not been paying tax has to be brought under the fold. This also means that the systems must be in place to allow seamless transactions with few complications. This would take time as has been noticed even for the income tax department going online for tax payments.
The third area that is more at the government's levels pertain to the compensation structure and process where timing is important. Presently states know the composition of goods that are produced and taxed and are able to budget for the same. But once there is a single point of collection which will be the Centre, which is then redistributed, the timing becomes important.
This is so as states have to draw up their budgets based on certain assumptions of the revenue flows from taxes. If there are shortfalls and they are unable to meet their expenditures or end up borrowing more, then the FRBM norms will be violated. The Centre has to keep this in mind as to begin with the transactions cannot be seamless. An option is to allow states a band of deviance from the 3 percent fiscal deficit norm for the next 3 years so that their development activity does not get impeded.
The real test of GST hence begins with the passage of all the formalities and it is hoped that it has been thought through. The euphoria at the political level is justified, but at the micro level the consequences are unsure. Adjusting to a new system for paying taxes will be a challenge for the tax payers as well as the states.
At the household level, the possibility of prices going up in near terms looks likely. Consumer products typically will see an increase in prices or limited decrease if rates fall sharply. But still it may be expected that the CPI index may not be very significantly impacted and could be in the region of 0.2-0.3 percent.
But a start has to be made and this is where we can feel sanguine about the future as the GST will enhance efficiency and could in the long run make goods cheaper as the cost of compliance comes down. Welcome GST, but wait and watch.
The author is chief economist, CARE Ratings. Views are personal