Ambit Capital Note on Economy: GST – The journey has only begun


 

Contrary to popular belief, the passage of the GST Constitutional Amendment marks only the beginning of a long process that should ultimately result in the implementation of a unified GST in India at best by 2HFY18. Although the adoption of a unified GST is a major step forward from a long-term perspective, in the short-term we highlight that this is likely to result in: (1) a mild pick-up in inflation as hitherto untaxed goods and services are now brought under the tax net, (2) a meaningful loss of jobs in the informal sector as this sector will no longer be able to fly under the radar of the taxman, and (3) consequently trigger pro-electorate measures in the form of higher revenue expenditure from FY18 onwards as the Central Government begins preparing for the 2019 General Elections.

The Event

The Rajya Sabha (i.e. the upper house of Parliament) yesterday passed the GST (122nd constitutional amendment) bill thereby empowering the Centre and the state legislatures to have concurrent powers to make laws on GST.

So is GST implementation likely by April 1, 2017?

Contrary to popular perception, the passage of the GST Constitutional Amendment marks only the beginning of a fairly tedious legislative and operational procedure that should ultimately result in the implementation of a unified GST in India. Three key inter-related procedures need to be completed successfully to pave the way for GST implementation hereon, namely:

  • Legislative procedures: The GST constitutional amendment will now need to be passed by 50% of state assemblies. Thereafter, the Lok Sabha and the Rajya Sabha will have to pass the central GST Bill with a simple majority. Then the states too will have to pass their own GST Bills.
  • Consensus-building regarding the GST rate and exclusion: The GST council will have to be constituted and then this body will have to reach a consensus regarding a series of contentious issues regarding the GST rate, the exclusion list, applicability limits, principles of supply, special provisions to certain states, and a host of other rules and regulations.
  • Operational procedures and technological backbone: A technological backbone to link the taxation systems of the states and the centre needs to be created and operationalised in the run-up to GST implementation.

As highlighted in our note dated August 1, 2016, we hence expect the Government to miss the April 1, 2017 deadline of GST implementation and expect GST to be implemented at the earliest by 2HFY18.

Leaving aside the politicking required to expedite the passage of GST through the state assemblies and leaving aside the horse trading that will take place over the nitty gritty of the GST Law (which will have to framed and passed through Parliament), the main reason for our politicians taking it easy on GST implementation is the fear of job losses. Specifically, whilst the formal sector (especially large-midsized companies) will benefit from GST (due to scale economies around manufacturing and logistics), the casualties will be the mom & pop companies which currently fly under the radar of the taxman. The latter sector accounts for 6x as many jobs as the former sector; hence the ruling dispensation’s apprehension of GST adversely impacting jobs even as it benefits listed companies.

Will GST be tax revenue accretive?

Whilst it is not clear whether GST will be indirect tax revenue accretive (as this will be a function of the GST structure that the GST council agrees to), it is likely to boost direct tax revenue collections from the time it will be implemented.

Even in its diluted form it will be direct tax revenue accretive mainly because GST implementation is likely to result in lifting income tax collections as: (1) GST payments by tax-payers will be linked to their respective Permanent Account Number (PAN); and (2) the National Securities Depository Limited (NSDL) which maintains the Tax information System (TIN) will also look after the GST database. This integration of the indirect tax system with the income tax system will enable authorities to triangulate information, thereby automatically leading to improved tax buoyancy.

Will GST be inflationary?

As indicated in the Arvind Subramanian panel’s December 2015 report on GST (http://goo.gl/NepsSN)a revenue neutral rate (RNR) in the 15-15.5% range with a lower rate of 12% and a standard rate of 18% would have no aggregate inflation impact. However, a higher RNR with a lower rate of 12% and a standard rate of 22% would increase inflation by between 0.3-0.7%. Irrespective of the ultimate GST rate that the GST council agrees upon, inflation is likely to rise as hitherto untaxed goods and services will now be brought under the tax net.

How is GST implementation likely to affect BJP’s policies from FY18?

As highlighted in our note dated July 27, 2016, our checks in New Delhi suggest that the BJP high command is acutely aware of the adverse electoral effects this reform could create as GST implementation is likely to result in higher inflation, lead to loss of jobs in the informal sector and increase grievances amongst taxpayers.

Our checks suggest that this is likely to trigger two offsetting pro-electorate mechanisms in FY18-19 including: (1) the Government continuing with its pro-revex tilt that it first displayed in FY17 (see exhibit below); and (2) MUDRA – a scheme to give soft loans (subsidised by the Government) of Rs2-10 lakhs to low income self-employed people – receiving significant focus in the run-up to CY19 General Elections and potentially becoming the ‘MGNREGA’ of NDA-II.

Exhibit 1:  The revenue expenditure for 1QFY17 was higher than ususal

Source: Controller General of Accounts, Ambit Capital research

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