A taxing tale: Assessing the impact of six years of GST

Goods and Services Tax (GST) stands at a critical juncture six years after its implementation. Despite promising enormous benefits, it has fallen short and led to a decline in economic growth, especially for the unorganised sector.

—

GOODS and Services Tax (GST) has completed six years since it was launched on the midnight of June 30, 2017. It was billed as India's second freedom. In a repetition of the then Parliament's midnight meeting on August 14, 1947, the Parliament met dramatically in 2017 to hear the Prime Minister announce the launch of GST.

It was said that the fragmented Indian market would be unified into one and a parallel was drawn with 1947, when free India had come together as a union of states.

Promised gains from GST

It was said that introduction of GST in India would bring enormous benefits to the people, with a percentage increase in gross domestic product (GDP), decline in inflation, reduction in black economy, increase in tax collection leading to better public services, ease of doing business leading to increased investments, and so on. There were no negative notes that were made.

GST was under discussion since the late 1990s and the government finally implemented it in July 2017 after political parties and states reached an agreement in 2016. Several prosperous states were reluctant to implement GST since it was a last point tax which would be disadvantageous to them. 

Many states were brought on board with the promise that their revenue would be protected with a guaranteed 14 percent increase from 2015. They were also promised to be compensated for any revenue shortfall. 

Liquor for human consumption and petroleum goods are cash cows for the Centre and the states. They were exempted from GST so that in times of need they could be milked for extra revenue (as seen during the pandemic). 

The states agreed to give up their power of fixing rates in favour of a common tax rate for the country. A GST Council was set up consisting of finance ministers of all states and headed by the Union finance minister.

Also read: Supreme Court's judgment on GST Council: Does it promote or hinder cooperative federalism?

Decisions on the Rules and the rates were to be taken by voting, with each state having the same weight in the council. But the Rules were drafted in such a way that the Union government could stop a proposal if it did not like it. 

Further, the Union government could influence smaller states to vote in its favour to get proposals implemented even if some of the bigger states opposed them. 

The agreement between the Centre and the states was hailed as a shining example of 'cooperative federalism'. In fact, suggestions have been made to set up other Centre–state councils on matters such as subsidies and expenditures.

It was stated that 17 indirect taxes were being replaced by one tax, and the cascading effect of indirect taxes would be removed. Further, there would be fixed rates to ensure revenue neutrality and entry into states would be eased with the abolition of checkposts at state borders and so on. 

It was argued that the e-way bill would make it easier to track the movement of goods and make transportation easier. Computerisation, a necessary component of GST, was expected to lead to the digitisation of the economy and better tax compliance.

It was also said that GST was already applicable in 160 countries, with the earliest to adopt it being France, which instituted a GST as early as 1954, and India was on the right side of history in implementing a GST. 

Such extrapolations are tricky. What works in one country may not work in another country. The US does not have a GST and Malaysia had withdrawn GST in 2018. In any case, very few countries have fully implemented GST and most countries, including India, have a halfway house, which leads to its own problems.

GST assessment

GST is a very complex tax applicable on supply of goods and services. The definition of 'supply' itself is complicated, which culminates in many court cases. Further, it is calculated as value added tax, which requires suppliers to compile information on all inputs and outputs. The system works with the input tax credit (ITC).

Also read: Rising national income but declining welfare of people

Many fake companies that provide fake ITC to evade taxes have been detected. The government has stated that ₹30,000 crore of tax has been evaded. The actual amount would be higher, since only about 3 percent of the evasion is usually detected.

For the huge unorganised sector in India, keeping track of input and output is difficult and they are unlikely to computerise it. So, the unorganised sector with a turnover of up to ₹50 lakh is exempted above that, and if they make a turnover of up to ₹1.5 crore, they are under the composition scheme with a flat 1 percent tax.

But they neither get ITC, nor can they offer ITC to their buyers. Thus, they face a disadvantage vis-à-vis the organised sector, which benefits from ITC.

The result of GST is a shift in demand from the unorganised sector to the organised sector. This is being reported from leather goods, pressure cookers, the luggage industry, fast-moving consumer goods and so on. The shift in demand has led to a decline in the unorganised sector with many units closing down and leading to growing unemployment. The organised sector, being highly automated, provides few jobs.

It was expected that GST as a last point tax would benefit the poorer, consuming states. This was expected to reduce inter-state inequality. But the opposite has happened since the unorganised sector is concentrated in the poorer states. As this sector has declined, it has led to a greater adverse impact on the poorer states than on the richer states.

Indirect taxes are inflationary since they are like prime costs for business. So, common items of mass consumption have been exempted from GST. Many government essential public services, like education, water supply and legal services are exempted. 

Many essential items are kept at a five percent tax rate while luxury items are at a 28 percent tax, with the sin goods having a cess on top. There are special rates for precious items and such multiplicity of taxes has made GST complex, making it easy to evade taxes.

Also read: Panel discussion on the recent developments in federalism: Separation of powers, reservation and GST

Implementing GST did not result in a decrease in the inflation rate or an increase in the rate of growth of the economy or a check on the black economy. Of course, many factors impact these variables. For instance, demonetisation was a major disturbance just eight months before the launch of GST and it had damaged the economy severely. 

Post-GST, even the official rate of growth of the economy fell from 8 percent to around 3 percent just before the pandemic hit the economy. If the adverse impact on the unorganised sector could be independently measured, the actual rate of growth would have been zero percent.

Tax revenue

Revenue collection from GST has been on the rise. It started from around ₹90,000 crore per month in 2017. Now, it has even reached around ₹1.8 lakh crore with an average of about ₹1.6 lakh crore. The surge in revenue collection is seen as a sign of success brought by GST, but is it so? Does this signify better compliance and less black income generation?

The GDP in 2016–17, the year before the GST was implemented was ₹154 lakh crore and in 2023–24, is expected to be above ₹300 lakh crore, an increase of 95 percent. This is more than the increase in average GST collection at 77.8 percent.

If the GST compliance had improved, it would have risen by much more than GDP, as the indirect tax to GDP ratio would have gone up. Further, since the organised sector is growing at the expense of the unorganised sector, where the GST is collected, the increase in GST should have been much more.

Various governments have collected more from liquor, petrol, goods and imports. So, indirect tax collection should have risen by much more than 95 percent. It shows that compliance in the organised sector is deteriorating.

Conclusion

The various promises of GST have been belied and only some of the key aspects are discussed in this article. The GDP growth has declined, inflation rate has not fallen and the black economy continues to thrive.

Also read: Service charge saga: From dal makhani to WWE in less than one NCR-minute

The unorganised sector, a major employer in the economy, is damaged and it is leading to an economic slowdown. The backward states which were expected to benefit have not reaped any benefits, due to the decline in the unorganised sector.

All of this is a result of GST being too complex for the highly differentiated Indian economy. The complexity has been amplified as the government is trying to tackle many issues with GST being the only instrument. The result has been a halfway house which is neither here nor there.

The ease of doing business has not come about and investment rates have not increased. An alternatively simpler GST exists but the government is not willing to admit its failure. Further, while the benefits have not accrued to the country, fiscal federalism has been dented, which will have long-term consequences.

The question remains: Does GST also fall foul of the basic structure doctrine? 

Arguments here are based on the author's book, Ground Scorching Tax. 2018