Inequity of GST


A share-market investor was exuberant over the introduction of GST, hoping that it would lead to a “bull phase” in the markets. Theoretically, he is right. The growth rate will increase, but whether the fortunes of Narendra Modi will enter a bull phase is the crucial question before voters.

The Government in Australia has proposed to increase the rates of GST from 10 per cent to 15 per cent; and to bring health, education, and fresh food items under GST. These were exempted thus far. The leader of the Opposition criticised these proposals saying, “You increase the GST, you increase the number of products it applies to, you hit poorer people the hardest.” The reason is that the poor use more of their incomes for consumption. A poor household may earn Rs.8,000 per month and use Rs.7,500 for housing, food and clothing. An increase in GST of, say, five per cent, would mean an additional expenditure of Rs.375 per month. This would be about five per cent of the household income. On the other hand, an upper class person may earn Rs.10 lakh per month and spend Rs.2 lakh on consumption. He would pay an additional tax of Rs.10,000 due to increase in rates of GST. This would amount to only one per cent of his income. The poor will pay five per cent more taxes while the rich will pay only one per cent more. The Rs.375 paid by the poor household will create much greater distress in the family than the Rs.10,000 paid by the rich household.

A similar debate is raging in Malaysia where GST was implemented recently. A survey conducted by a Malaysian newspaper indicated that families earning more than 12,000 Ringgit were positive about GST while those earning below 5,000 Ringgit were largely unhappy. One person who was surveyed said :”The government wants to tax us and tells us to save. But then it goes and buys a new private jet.”

Studies conducted by government institutions in India portray a contrary picture, however. The Task Force constituted by the 13th Finance Commission has concluded that GST will benefit the poor. But the study is grossly flawed. It says that the poor will benefit from a reduction in prices of manufactured goods, textiles in particular.

It is true that the price of all textiles produced in the country may decline. But that does not mean that price of textiles consumed by the poor will also decline. Presently, many goods that are consumed mainly by the poor such as coarse cloth, bicycle tyres and rubber slippers are taxed at lower rates. Taxes imposed on these goods will increase in the GST regime. The prices of goods consumed by the poor will, therefore, face two contrary effects. Their prices will decline due to the overall improvement in efficiency but the same prices will increase due to higher rates of taxes imposed on these items. The Task Force has remained surprisingly silent on this issue.

The Task Force has recommended that the exemption of Rs.1.5 crore in excise duty that is presently available to small industries be removed. This will hit small industries hard. These industries happen to be the major employers. Many will close down, aggravating the employment situation. Most amusingly, the Task Force has simultaneously assumed that full employment is prevalent in the economy. This assumption is total rubbish. Unemployment will certainly increase due to the implementation of GST.

The Task Force has said that the value of goods produced by a worker will increase by around one per cent. A worker who is presently producing Rs.100 worth of goods will produce Rs.101 worth of goods after GST is implemented because the economy will become efficient. The Task Force concluded from this that wage rate will increase by one per cent. This is, again, nonsensical. The wage rates are determined mainly by supply and demand; not by the amount of goods produced. A factory may install an automatic machine and that will lead to an increase in the production made by the worker. But wages will not increase because other unemployed persons will be more than happy to work at the previous wage rates. Another study by National Council of Applied Economic Research has similarly made many false assumptions, concluding that GST will lead to enhanced welfare. The Government is trying to implement GST on the basis of these inaccurate studies. The professors who have done these studies will surely make good money, but Mr Modi may well lose his job because of the backlash from voters!

It has been suggested in economic literature that a reduction in rates of income tax could compensate for the negative impact of GST on the poor. This will not work in India since most workers are employed in the informal sector and pay no income-tax. Another suggestion is that subsidies such as those on foodgrains could be increased and targeted at the poor. This will be self-defeating. The purpose of GST is to make the economy efficient. It is well known that welfare programmes are hugely inefficient with such endemic problems as bogus ration cards. The increase in efficiency from the introduction of GST will, therefore, be cancelled by a decline in the efficiency of welfare programmes.

That said, GST does have its positive aspects. It will lead to an increase in taxes on consumption and a corresponding decrease in taxes on incomes. I am in favour of this overall approach because India is a developing country and we need to reduce consumption and increase investment. This comes with a caveat, however. The reduction in consumption should be of the rich, not of the poor. It is imperative to increase the taxes on consumption on items such as cars, flat screen TV sets, smart mobile phones and the like; and reduction in taxes on items mainly consumed by the poor such as bicycle tyres and rail travel in second class. The GST regime does not make a distinction between consumption by the poor and the rich. It is like asking the malnourished poor to compete with the landlord’s well-fed goon.

It is true that there is a global consensus in favour of GST. Only 49 countries had implemented GST in 1989 against 160 today. It would be useful to quote Rudyard Kipling – “If you can hold steady your mind when all others are losing theirs, then you are a man.”

Prime Minister Modi has to decide whether he will follow the negative path being pursued by other countries; or will he hold his head high amidst the clamour around him.

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