India’s bold GST reform expands tax base, but too soon to celebrate?

Five years on from its inception, the simplified GST regime has seen tax revenues in India soar to record levels.

Anand Purohit | moment | Getty Images

It’s been 5 years since India introduced its Goods and Services Tax and while government revenues have soared, some analysts say it may be too soon to celebrate.

India – that fifth largest economy in the world with more than $3 trillion GDP — has managed to double its tax base since the introduction of GST in July 2017.

Although collections have increased and compliance has improved, analysts point out that this does not necessarily translate to economic growth.

GST revenue grew from around 7.2 trillion rupees or US$90 billion a year Fiscal year 2017-2018 to 14.8 trillion rupees in the fiscal year ending March 2022show government statistics.

Even though the collection of GST revenue is higher in absolute terms, some wonder if the growth in collections will be sustained.

“The GST cannot stimulate growth. Rather, growth encourages GST collection. Therefore, the future GST collection will depend on the growth performance of the Indian economy. If growth slows further, GST collection will be negatively impacted,” senior fellow at New Delhi-based think tank Observer Research Foundation Abhijit Mukhopadhyay told CNBC.

“Somehow a rule of thumb has emerged that if the monthly GST collection exceeds Rs 1 trillion or $12 billion, it is a success,” he said.

Among other things, rising inflation is likely to dampen demand and lead to lower revenues, Mukhopadhyay said. “The increase in raw material and food prices has contributed significantly to the collection of the GST. Ultimately, if inflation continues to rise, it will have a dampening effect,” he said.

What India’s GST has achieved

The goods and services tax – enacted by Prime Minister Narendra Modi’s government – included 17 local levies such as consumption tax, service tax and VAT and 13 other fees.

As part of the nationwide tax regime, these different taxes apply have been replaced by four tax rates ranging from a 5% tax on basic necessities to a maximum of 28% on things like cars and luxury items.

“The GST remains a landmark tax reform of independent India, despite many implementation issues encountered in its first five years,” Rajan Katoch, a former Indian heavy industry minister, told CNBC.

Not only has it strengthened coordination within the state, but it has also “improved tax lift, curbed indirect tax evasion and drawn increasing numbers of smaller taxpayers into the formal system,” Katoch said.

The introduction of the GST mechanism helped consolidate multiple indirect tax rates to create a cleaner and predictable structure.

Radhika Rao

Senior Economist and Executive Director, DBS Bank, Singapore

Before the introduction of GST, India’s tax system – often complicated and impenetrable – was notoriously difficult to navigate.

The “good and simple tax,” as Modi has described it, has increased the number of registered GST taxpayers to 13.6 million from around 6 million five years ago, according to figures cited by India’s Finance Minister Nirmala Sitharaman in an article in local media.

Effects on foreign investments, “black money”

Views differ as to whether the GST has made India a more attractive investment destination or whether it has been effective in curbing ‘black money‘ – undeclared income on which no taxes have been paid.

Black money has long been known to play a role in India’s economic activity. In 2012 the Indian Treasury published a “white paper” on black money, defined by the government as “any income on which taxes imposed by the government or public authorities have not been paid”.

Former industry secretary Katoch claims GST had an impact on black money.

“Since [GST] led to the formalization of transactions that were previously informal in nature, yes, it would have led to a reduction in undeclared or unrecognized cash flows,” he said, adding that it’s difficult to gauge the magnitude of the reduction.

But not everyone agrees.

“Black money is generated in real estate, trade and politics. In all three cases, cash transactions continue. Neither demonetization nor tax reform had much impact,” Sanjaya Baru, a New Delhi-based economist, told CNBC.

Demonetization refers to the Modi government’s controversial move in 2016 to withdraw high-denomination banknotes from legal tender in order to flush out black money.

The government had hoped that the tax reforms would make India more attractive to foreign investors, but that may not have materialized, according to Baru, who was media adviser to former Prime Minister Manmohan Singh.

In theory, the GST aims to make India more attractive to foreign investors, especially in the manufacturing sector,” he said. “In practice, however [foreign direct investment] in manufacturing wasn’t very impressive.”

GST cannot stimulate growth. Rather, growth encourages GST collection. Therefore, the future GST collection will depend on the growth performance of the Indian economy.

Abhijit Mukhopadhyay

Senior Fellow, Observer Research Foundation, New Delhi.

India’s World Bank Doing Business ranking climbed to the Ranked 63rd in 2020 out 100th place in 2017 – a jump of 37 places in a period of 3 years.

While not directly attributable to India’s tax reforms, tax payment is one of nearly a dozen factors used to measure the ease of doing business in the countries evaluated.

“The administration’s reform efforts targeted all areas measured by Doing Business, with a focus on paying taxes, cross-border trade and handling bankruptcies.” according to the World Bank’s 2020 report.

Political wrangling ahead

Rising inflation is not the only cloud on the horizon for the GST system.

India is expected to make a politically precarious decision in August on whether to bring gasoline, diesel and so-called “sinful goods” like liquor and tobacco under the GST, a federal tax.

“Petro products should be included in the GST framework. That can boost revenues dramatically and will also dampen inflation,” said Mukhopadhyay of the Observer Research Foundation.

However, it is an ambitious goal and could become a political challenge. The duties on these goods are now collected by State governments, some of which are led by political opponents, and it will not be easy to convince them to forego this lucrative source of income.

Irrespective of this, the federal government is also facing other demands from the state governments.

Since 2017, the federal government has been compensating state governments for some tax revenue they lost because of the GST.

That ended on June 30, but states are now seeking an extension, citing the two “lost.” pandemic years,” equity strategist at Mumbai-based macroeconomics firm WealthMills Securities Kranthi Bathini told CNBC.

For Modi’s government, this demand could be the start of a long political struggle – even in states ruled by his ruling BJP or its political allies.

Comments are closed.