Chief Economic Advisor Arvind Subramanian talks about the challenges of GST and explains why states will be its “biggest beneficiaries”, underlines the government’s commitment to the April 1, 2017, deadline for rolling out the tax reform, and says he has not been “muzzled” in any way by the NDA government.
Formerly an economist at the International Monetary Fund, Arvind Subramanian was appointed the Chief Economic Advisor to the Government of India in October 2014. Last year he headed a panel that was assigned the task of coming up with possible tax rates under GST, which would strike a balance between the industry and the states. A senior fellow at the Peterson Institute for International Economics, Subramanian has authored five books and is a widely cited expert on growth, trade and the economics of India and China.
P VAIDYANATHAN IYER: In a report submitted to the government last December, a panel headed by you had recommended a revenue-neutral rate (RNR) of 15-15.5 per cent for the GST (Goods and Services Tax), with a standard rate of 17-18 per cent to be levied on most goods and all services. Former finance minister P Chidambaram said in the Rajya Sabha that if the government is not putting the 18 per cent cap on tax rate in the Constitution Bill, it must mention it after three months. So what is the debate on the optimum level of GST rate all about?
If you look at 2016, I would argue that we have had at least four big legislative achievements and potentially transformational ones. One is the GST, the second of course is the Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Bill, the third is the Monetary Policy framework, and then of course the Bankruptcy Code (2015). These are the four major legislative achievements this year. On the economic front, my own view is that the inflation outlook is actually not bad at all. I think if pulses, vegetables and fruits inflation comes down in the future, we could be looking at a relatively benign inflation environment. So, the overall policy achievements combined with the new development schemes on the economic front make this a time for true celebration, as opposed to just celebrating the GST. I am not discounting the challenges… private investment remains weak, exports still have to pick up, we still have the corporate balance sheet problems, which are hanging over us like a legacy.
Coming to GST, there are a couple of things there. In our report, we said (standard rate of) 17 to 19 per cent (to be levied on most goods and all services), but it was conditional on a number of policy assumptions and other things. So, I think, going forward we have to decide on these policies. For example, how are we going to tax code, how are we going to deal with compensation (for states) and then how will cesses be levied after the GST is rolled out.
Let’s take compensation, for example. We don’t know how much it is going to be but the view we took in the report, and which I stand by very strongly, is that compensation is a temporary phenomenon. I believe it will be much more short-lived than people think. But it’s a temporary thing and we should not burden the permanent structure of GST taxation with a temporary phenomenon.
We have heard the point of view of the states. All states are saying 23, 24, 25 per cent (GST rate). Let me say two or three things on that: I don’t think any state has done serious calculation. Of course the data doesn’t exist yet and we are going to be doing that. Second, I think there is a great fear of the unknown for the states and so they tend to want higher rates. Remember, the states are going to get a source of tax that they never had in their history, which is on services, and they are going to be the biggest beneficiaries of that.
Finally, (states) have to face the electorate, and so you don’t want to have higher taxes; and the Centre is backing you. Even if you fall short, the Centre has said that it is going to compensate you. So, I don’t completely understand what’s going on, both in terms of the analysis that they (the states) have done and in terms of politics. Let’s see how it plays up. (The GST rate will be decided in the coming months by a council that will have the Finance Minister and representatives from every state).
P VAIDYANATHAN IYER: Critics have said that this is a terrible GST framework, big ticket items have been kept out of the GST framework… So the scope for moderation in tax rates does not really exist?
I think the standard argument — let not the best be the enemy of the good — to some extent is true, but I think there is a deeper point. Take Canada, take the European Union, they all have a very flawed GST. I think we have to start and get our feet dirty, and then we can learn as we go along. That is the way it’s going to happen. Could it (the GST) be better? Of course. But that is an incomplete understanding of how a complicated country like India works.
SUNIL JAIN: Since so much of the CPI basket is under low GST rates, what is possible is that we will have a high rate of taxation even while the CPI remains low, since that basket of goods will be taxed at a lower rate. Also, given how VAT rates have risen, don’t you think GST rates could also go up in time?
You need to take note of two things to understand why VAT (Value Added Tax) rates might have gone up. We know that at least in some states, such as Gujarat, lots of exemptions were given. So it is not surprising therefore that if you get exemptions on one side you have to have higher rates on the other. In the case of GST, however, compliance will be critical.
Going forward I think there’s going to be more of a check on granting exemptions of that sort.
I don’t know the exact time when VAT was increased but certainly as growth started decelerating, you know after 2013 or so, that is when you could understand why (VAT increased). During the growth boom, you didn’t have to raise rates. But once the growth began to slip… it could have been entirely related to the economy as well. We will have to see going forward what the experience is going to be.
Just see the amount of information that is going to be out there and to me it is quite extraordinary. At the heart of compliance is the IT network, where every invoice of every dealer will be captured, with around 3-5 billion invoices expected to be matched online automatically every month. I have no doubt that over time, compliance benefits are going to be huge. Once traders know this is going to happen, they will automatically adjust their behaviour. Once compliance rises, rates will fall.
P VAIDYANATHAN IYER: Everyone is talking of April 1, 2017, as the implementation date for the GST.
The Prime Minister has said that by the end of the month, he wants16 states to have ratified. Immediately after that the President will notify (the GST Council, which will then decide the new tax rate and other issues). The IT work has been going on for a long time, the front end is common to all states. For setting up the back end, I think for 16-17 states the Centre is doing it, the rest are doing it themselves.
Meanwhile, the GST Council will be set up and I think there is going to be tough bargaining on many issues, which will then lead to three pieces of legislation — Central GST (CGST), State GST (SGST) and Integrated GST (iGST) — that will eventually have to be enacted. We are expecting it to come up in the Winter Session. If the legislation is passed in the Winter Session, we then have three months to do the trial run. If we can get the Bills in Parliament in the Winter Session, then I think it is doable (meeting the April 1, 2017, deadline). The government is certainly committed towards it.
P VAIDYANATHAN IYER: What is your view on the Congress’s demand for legal ring-fencing of the GST rate?
This whole ring-fencing in the Constitution only started in late 2005. In virtually no country in the world tax rates are put in the Constitution. It was odd (the Congress’s demand — overall rate be capped at 18 per cent and scrapping of an additional 1 per cent tax designed to compensate manufacturing states that fear losing out on revenue) for a number of reasons. Firstly, tax decisions are political decisions and they have to be a continued decision. If you have a calamity, you may have to raise rates. The other reason why in the Indian context it (legal ring-fencing) is not doable is that we are chained to a GST arrangement in which the tax in high rates has to come from within the structure of GST. In many countries what they do is that they have a GST, and then they say you can levy taxes on environment-unfriendly goods etc outside the GST. But the way it (GST in India) was structured that was not possible. That is also the reason why we couldn’t put a cap of 18 per cent, because you need another rate for demerit goods (a good or service whose consumption is considered unhealthy, degrading, or socially undesirable). I do not know about the politics behind it, but basically for economic and policy reasons, it was not a good idea at all. The GST Council will meet and come up with the rates.
SANTOSH TIWARI: If any state is not abiding by the rules, would it be possible for the Centre, or the Centre and the states together, to impose penalty, like suggested in the 13th Finance Commission report?
There will be a dispute resolution mechanism, and these are precisely the issues that will have to be taken up. The GST Council is going ahead with the recommendations (of the 13th Finance Commission). But I don’t think they are discussing a situation where there will be presumptions that these decisions will be adhered to, and if they are not, there will be consequences.
HARISH DAMODARAN: If I am a steel manufacturer, and I pay 16 per cent as my duty, I can set it off against my imports. But if I am a consumer, and have to pay 18 per cent under the dispensation, what do I set off? How will you sort this out?
When you are going to change these rates, there are going to be some distributional shifts, but who exactly is going to gain and lose is something that is going to depend on the final structure of rates and the consumption basket of a particular set of people. The CPI describes it on an average but in the report (December 2015) we also do a calculation for the bottom 40 per cent, as to how the taxes will impact them. The bottom 40 per cent is more protected than the average CPI because they consume a greater portion of exempt items. And, the bottom 40 per cent is also protected by the PDS (Public Distribution System). The self-definition of middle class is really interesting in India especially if you see who pays the taxes — it is the top 5, 6 or maybe 7 per cent. So the man who pays the lowest tax also thinks of himself as the middle class.
SUNIL JAIN: What is the difference between the GST Bill proposed by the Congress and the one that the NDA government has presented? The Finance Minister has said the Congress’s GST would not have been passed by any state government. What did he mean by that?
The 2011 Bill and its subsequent variants had no compensation for states and at the time the opposition states were the net manufacturing states. The second part, which even the Finance Minister (Arun Jaitley) mentioned, was that the Centre had agreed to compensate the states for the reduction in the CST (Central Sales Tax) but that was never paid. When the GST didn’t come in, when the states didn’t get any compensation, they stopped trusting the Centre.
P VAIDYANATHAN IYER: Is the problem of NPAs (non-performing assets) too large to be resolved by the initiatives of the RBI?
A series of steps have been taken but I don’t know entirely what its impact has been. I look at the credit growth numbers and see that they are very weak. Also in the last couple of months, we have seen a further reduction, both in short rates and long rates, about 25 basis points, and almost nothing has passed through in terms of bank lending. So it seems clear that the state of the bank balance sheets is inhibiting their ability to either lower rates or to provide more loans. Aggregate industry credit is now quite weak, in real terms it is negative I think. What is also interesting is that if you look at the composition of this credit, a lot of it is going to infrastructure, steel and metals. We know that these are already heavily indebted sectors. So non-indebted sectors are actually relatively starved for credit.
Given all the positives on the economic front, the one side where the challenges still remain is the banking side and the corporate balance sheets side. We have to see how this thing works out going forward, and recapitalisation will be a part of it.
COOMI KAPOOR: You have worked internationally as an economist. How was it like working with the Government of India? Earlier when you were an outsider you felt that the government inflated its projections. What do you feel now?
I have been here almost 31 months, and every day has been a 24/7 high. It has been spectacularly exciting because my bosses and my team have given me a lot of space. The government has been very very open to listening. What they finally act on remains to be seen and it is their prerogative, but in terms of the scope to analyse, it has been almost unrestricted.
On the other question, you have certain luxuries as an outsider, which you trade for other luxuries as an insider. As an insider, you get so much opportunity to be a part of things… The government has given me a lot of space to be completely candid, I am not in any way muzzled.
COOMI KAPOOR: What about inflated projections?
I cannot and will not say that. I do think that our whole statistical apparatus is beyond political influence, the people are of impeccable integrity and the changes have nothing to do with the change in government. I need to say this very categorically, that the methodology (for calculating growth rate) changed. That coincided with perceptions about GDP numbers, and so the notion that, you know, the uncertainties about the numbers were linked to the changes is completely wrong. Changing the methodology has certain consequences, but the doubts that have been expressed would have been true even with the old methodology. People like to say that the new government came, the methodology changed, and hence the doubts. But that is a completely preposterous chain of causation.
Then the question remains as to what about the technical analysis of the numbers. As we said in the mid-year economic analysis, relative prices have changed so much because of oil prices, every methodology is going to remain problematic, even the old one. That is what we are struggling with. But we also have to look at how to deal with this internally and we are constantly doing it.
SHEELA BHATT: How will the GST impact the average Indian housewife?
Let’s say there will be direct and indirect effects. The direct effect will be the absence of the negative — that because of GST, prices will go up, that will not happen. There will be two-three indirect but very important benefits. If the timing works out, then over time, the government will acquire a lot of resources, and hence will be able to spend more on health and education for children. Then, if she is a small entrepreneur and now doesn’t get credit — because there are no records, the banks don’t trust her — then, once she files taxes as an entrepreneur, she will be able to build a credit record. So the whole possibility of financial inclusion and access for the average housewife will be enormous over time. There will be less interface with tax administrators, less corruption because of easier compliance… there will be a lot of improvement.
SHEELA BHATT: Earlier there was speculation about some leaders in the BJP not wanting the GST because they felt it could lead to high inflation in a year-and-a-half, which would be closer to the 2019 general election.
I don’t deal with the party. I have dealings only with the government.
SHEELA BHATT: The BJP issued a statement which said that the GST is the biggest reform since 1947. Do you agree?
See, no single piece of reform can be a be all and end all. Reforms are cumulative. I don’t think anyone has said GST will change the world.
I think two aspects of this are unprecedented. It is one of the most ambitious tax reforms in Indian history. I have looked at other countries that have tried to do this, and in big countries with federal structures… to achieve this is unprecedented.
Second, in terms of cooperative federalism, this is a completely new experiment. I may sound like an outsider here, but when you think about what the European Union did after World War II, they said we have to get into the habit of negotiating through every issue. Here too, we will be forced to think of a new form of governance, in the tax sphere, but it is a new experiment where the Centre and the states will have to constantly thrash through issues.