India’s bold GST reform broadens the tax base, but is it too early to celebrate?

India's bold GST reform broadens the tax base, but is it too early to celebrate?
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Five years after its launch, the simplified GST scheme has resulted in record tax collections in India.

Anand Purohit | Moment | Getty Images

It has been five years since India introduced the Goods and Services Tax, and while the government’s revenue collection has increased, some analysts say it may be too early to tell.

India – the the fifth largest economy in the world with more than 3 trillion dollars in GDP — After the introduction of GST in July 2017, it managed to double the tax base.

While collections have increased and compliance has improved, analysts note that this has not necessarily led to economic growth.

GST collections have increased from Rs 7.2 trillion or $90 billion Fiscal year 2017-2018 tone 14.8 trillion rupees in the fiscal year ending March 2022government statistics show.

While revenue collections from GST are higher in absolute terms, some question whether the increase in collections will continue.

“VAT cannot increase growth. On the contrary, growth increases GST collection. Hence, future GST collection will depend on the growth performance of the Indian economy. If growth slows further, then it will have a negative impact on GST collection,” said Abhijit, senior fellow at Observer Research Foundation, a think tank in New Delhi. Mukhopadhyay told CNBC.

“For some reason there has been a rule that if the monthly GST collection crosses 1 trillion rupees or $12 billion, it is a success,” he said.

Mukhopadhyay said, among other things, rising inflation would dampen demand and could lead to lower collections. “Rise in commodity and food prices has contributed significantly to GDP growth. If inflation continues to rise, it will eventually 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 excise duty, service tax and value added tax. and 13 other charges.

Under the nationwide tax regime, these taxes varied it was replaced by a four-rate structure, from a 5% tax on basic goods to a higher rate of 28% on things like cars and luxury items.

“Despite the many implementation problems experienced in the first five years, GST remains the landmark tax reform of independent India,” Rajan Katoch, India’s former heavy industries secretary, told CNBC.

It not only strengthened coordination within the federal state, but also “improved tax portability, curbed indirect tax evasion and attracted more and more small taxpayers to the formal system,” Katoch said.

The introduction of the GST mechanism has helped to introduce multiple indirect tax rates to provide a cleaner and more predictable structure.

Radhika Rao

Chief Economist and CEO, DBS Bank, Singapore

Impact on foreign investments, ‘black money’

There are differing views on whether the GST will make India a more attractive investment destination or whether it will be effective in curbing “black money” from unreported income where no tax is paid.

Black money has long been known to play a role in India’s economic performance. In 2012, the Ministry of Finance of India released a “white paper” on black money, defined by the government as “any income on which taxes imposed by the government or public authorities are not paid”.

Former industries secretary Katoch claims that GST has affected black money.

“Since then [GST] resulted in the formalization of previously informal transactions, yes, this would lead to a reduction in black or unaccounted cash flows,” he said, adding that it was difficult to estimate the extent of the reduction.

But not everyone agrees.

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

Demonetization refers to the Modi government’s controversial move in 2016 to withdraw high-denomination notes as legal tender. as a way to clean black money.

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

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

GST cannot increase growth. Conversely, the increase increases GST collection. Hence, the future GST collection will depend on the growth performance of the Indian economy.

Abhijit Mukhopadhyay

Senior Research Fellow, Observer Research Foundation, New Delhi.

India has risen to the top of the World Bank’s Doing Business ranking 63rd place in 2020 from 100th position in 2017 – 37 steps jump in 3 years.

While it cannot be directly linked to India’s tax reforms, tax compliance is one of nearly a dozen factors used to measure the ease of doing business in the countries ranked.

“The administration’s reform efforts have targeted all areas measured by Doing Business, with a focus on paying taxes, trading across borders, and addressing bankruptcy.” This is stated in the 2020 report of the World Bank.

Political conflicts ahead

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

India is expected to take a politically dangerous decision in August on whether to include petrol, diesel and “sin goods” such as liquor and tobacco under the GST, a federal tax.

“Petro products should be brought under GST. It can increase revenues dramatically and also reduce inflation,” said Mukhopadhyay of the Observer Research Foundation.

However, this is an ambitious goal and could become a political challenge. Duties on these goods are already collected by state governments, in some cases led by political opponents, and persuading them to give up this lucrative revenue stream will not be easy.

Separately, the federal government faces other demands than state governments.

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

It expired on June 30, but states are now seeking an extension, citing two “lost”. “pandemic years,” Kranthi Bathini, equity strategist at securities macroeconomics firm WealthMills in Mumbai, told CNBC.

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

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