In lower income countries GST has hurt consumption by increasing prices
With the NDA seemingly keen to reconvene Parliament in order to procure Rajya Sabha approval for the Constitutional Amendment on the Goods and Services Tax (GST), it is worth trying to understand the economic impact of this misunderstood tax, which seems to have been debated in India for over six years now without the most impacted constituency — the consumer — having a say in the matter.
Mixed economic impact
Contrary to what the current and previous administrations in New Delhi say, cross-country evidence suggests that the introduction of GST has no correlation whatsoever with GDP growth. Although the introduction of a single GST limits inefficiencies created by a heterogeneous taxation system, there is little evidence that it helps boost economic activity. In developed economies like New Zealand and Australia the introduction of GST does not seem to have hurt economic growth; but in lower income countries like Nigeria and Malaysia, GST does seem to have cramped consumption by increasing the sticker price that the consumer has to pay.
This negative impact on consumption then dampens GDP growth. It is, therefore, quite astonishing that in a low-income economy like ours, we have not even heard a murmur of protest from consumer groups with regard to the imposition of GST.
Structure is important
The introduction of GST will undoubtedly remove inefficiencies. For instance, the problem of double taxation which arises from India’s parallel — State and Central — systems of indirect taxation which, in turn, differ for goods and services. It will simplify the existing indirect tax structure. But the impact on economic growth remains ambiguous.
At the Revenue Neutral Rate (RNR) of 18 per cent, the government’s revenue will remain unaffected and hence the government cannot increase expenditure to stimulate growth. However, at a GST of 25 per cent, India’s tax-to-GDP ratio (which at 11 per cent is significantly lower than other emerging Asian economies’ of over 20 per cent) will increase by as much by 1-2 percentage points.
If the government spends these increased revenues of around $20-40 billion on capex, then GDP growth is likely to be positively impacted, especially as the fiscal multiplier (around 2.4x for India) comes into play.
A further complication is the mooted 1 per cent inter-state tax, supposed to be collected by the Centre and given to producing States. If levied, this can significantly reduce the benefits of moving to a harmonised GST, especially since, unlike the main GST, this 1 per cent is not offsettable (i.e. businesses which pay this 1 per cent will not be able to use this payment to claim tax relief). In this context, it is surprising that corporate India has not raised a hue and cry about this surcharge.
Loss to services
If GST is set at the RNR of 18 per cent, most goods which currently pay an effective tax rate of around 24 per cent will benefit.
Sectors, such as automobiles, FMCG and home-building materials, in particular, will be positively affected. At a rate of 25 per cent, however, most goods will be negatively impacted; however, at this rate government revenue and, hopefully, government spend on hard asset creation will receive a boost and thus drive GDP growth. However, at both rates — 18 per cent and 25 per cent — Services will be negatively impacted, as it is currently taxed at 14 per cent.
Services account for nearly 60 per cent of India’s GDP and a steep rise in the sticker price of Services will almost certainly adversely impact consumer spending in India.
In the context of listed stocks, the Services sectors that will be most acutely impacted are aviation, media, telecommunication and to some extent Banking & Financial Services.
Whilst given the sheer amount of legislative and logistical work that remains to be done, it is unlikely GST will be implemented before April 2017, it is a shame that a complex tax change — whose overall economic impact is ambiguous, impact on consumers is adverse, and beneficial impact on businesses is being curbed by retrograde additional taxes — is not being debated properly either in Parliament or in the media.
The writer is CEO – Institutional Equities, at Ambit Capital. Views are personal