Six years of a flawed GST: Belying the great expectations
The detection of widespread input tax credit fraud and the presence of fake companies shows that large-scale tax evasion continues. This has also meant less resources for the states
The Goods and Services Tax (GST) in India, introduced in July 2017, has just completed six years of operation. When it was launched, it was hyped as the country’s ‘second freedom’, since it was expected to unify the ‘fragmented’ Indian market just as 1947 had brought together hundreds of princely states to form the Indian Union.
GST was also expected to benefit people by helping increase the GDP by 1–2 per cent, reducing inflation, curbing the black economy and increasing tax collection, leading to better public services, ease of doing business, [in turn] leading to increased investment and removing the cascading effects of indirect taxes. The performance on each of these counts, however, has been disappointing.
Several prosperous states were reluctant to apply GST since they felt it would be disadvantageous. They were brought on board with the promise that their revenues would be protected, with a guaranteed 14 per cent increase every year over the base of 2015. They were also to be compensated for any revenue shortfall.
Liquor for human consumption and petroleum goods are cash cows for both the Centre and the states. To bring states on board, they were kept out of the GST bracket so that in case of need, liquor and petroleum goods could be milked for extra revenue. This came in handy for the Centre and the states during the pandemic.
The states agreed to give up their power of fixing tax rates in favour of a common tax rate for the country. This dented federalism. A GST council was set up, consisting of all the finance ministers of the states, headed by the Union finance minister. Decisions on the rules and the rates were to be taken by vote, with each state having the same weightage in the council.
But the rules of functioning of the council were drafted in such a way that the Centre could exercise a veto. Further, it could influence the smaller states to vote with it to get proposals implemented, even if some of the bigger states opposed them.
The agreement between the Centre and the states was, however, hailed as ‘cooperative federalism’. In fact, suggestions have been made to set up similar Centre–states councils on matters like subsidies and expenditures. This idea is being floated so that the Centre can gain even greater control over the budgetary provisions of the states. That it would reduce the states’ autonomy and further dent federalism appears to hardly concern the Centre.
It was stated that since 17 indirect taxes were being replaced by one tax, the cascading effects of indirect taxes would be removed, rates would be fixed so as to ensure revenue neutrality, entry into states would be eased with the abolition of check posts at state borders, and so on.
It was argued that an e-waybill would make it easier to track movement of goods and ease transportation. GST requires computerisation, and that was expected to lead to digitisation of the economy and better tax compliance.
It was also claimed that GST is in operation in 160 nations, with the earliest adopter being France, which introduced GST way back in 1954—so why not India? But then, what may work in one country may not work in another country.
The USA does not have GST and Malaysia withdrew its GST scheme in 2018. Moreover, hardly any country has a full GST plan—most, including India have a partial adoption, which leads to its own problems.
As former finance minister Arun Jaitley said, a Mercedes car and a Hawaii chappal cannot have the same tax rate. Indirect taxes are regressive; a common rate of tax would make the system more regressive. To reduce regressivity, common items of mass consumption were therefore exempt from GST.
Several essential public services like education and water supply are exempt. Legal services are also exempt. Many essential items are kept at a 5 per cent tax rate while luxury items are at 28 per cent and the ‘sin goods’ have a cess on top. There are special rates for precious items. Such a multiplicity of tax rates has, however, made GST more complex and has enabled tax evasion.
Even items that do not attract GST end up paying some part of it when goods need to be transported. As trucks, batteries etc attract GST, the price of wheat—which is itself exempt from GST—also ends up reflecting the burden of GST.
A large number of fake companies have also sprung up which provide fake input tax credits to companies wishing to evade taxes. The government has officially admitted to successful GST evasion worth Rs 30,000 crore to date. The actual amount, however, would be many times more, since on an average only about 3 per cent of tax evasion is usually detected.
For the huge unorganised sector in India, keeping track of input and output is difficult, and they cannot afford to computerise either. While the unorganised units with a turnover of up to Rs 50 lakh are exempt and those with a turnover of up to Rs 1.5 crore pay a flat 1 per cent tax, they neither get input tax credit nor can they offer it to their buyers. Thus, they are at a price disadvantage compared to the organised sector.
The organised sector benefits from lower costs due to input tax credits, and their effective selling prices are thus lower than the prices charged by the unorganised sector. The result is a shift in demand from the unorganised sector to the organised sector. This has been reported by manufacturers of leather goods, pressure cookers, the luggage industry, FMCG products, etc.
The result has been a decline in the unorganised sector, with many units closing down and workers becoming unemployed. The organised sector, being far better mechanised and automated, ends up providing fewer jobs but higher profits.
It was also expected that GST as a point-of-sale tax would benefit the poorer states, which are mostly the consuming states. The opposite has happened, however, since the unorganised sector is concentrated in the poorer states.
Implementation of GST did not result in a lower inflation rate or an increase in the rate of growth of the economy either; nor has it been able to check the black economy. Post-GST, even the official rate of economic growth fell from 8 per cent to around 3 per cent just before the pandemic.
If the adverse impact on the unorganised sector could be independently measured, the actual rate of growth would have been close to zero. India has, therefore, not been the fastest-growing large economy in the world as official claims have put forward.
Revenue collection from GST has been on the rise, though. While the monthly collection has touched around Rs 1.8 lakh crore, the average for 2022–23 is Rs 1.51 lakh crore. This is an increase of 53.5 per cent in five years. Does this constitute a success for the GST regime, with better compliance and less black income generation? With even a growth of 14 per cent, as promised to the states, GST collection should have in fact increased by 92 per cent over five years.
So, while GST compliance has improved, leakages are still enormous. The corporate sector has grown much faster than the rest of the economy. E-commerce has grown at the cost of neighbourhood shops. Since most of the GST is collected from big businesses and their associates, the increase in collection of GST should have also been far greater than 53.5 per cent in the last five years.
The detection of widespread input tax credit fraud and the presence of fake companies shows that large-scale tax evasion continues. This has also meant less resources for the states.
So, the GDP growth has actually declined, inflation rate has not fallen and the black economy continues to thrive. The vast unorganised sector, which is the major employer in the economy, has been the loser. The overall economy had slowed down even before the pandemic.
Is GST then unsuited to the highly complex and differentiated Indian economy? Just because other countries, much smaller and with a more unified market and better infrastructure, may have implemented it is not reason enough to implement it in India.
The complexity has been amplified by attempts to tackle several issues with one instrument. The result has been a patchwork, and a structurally flawed GST regime. Consequently, GST has not improved ease of doing business, leading to a stagnant investment rate and slow growth.
An alternative, simpler GST regime is possible, but the government is not willing to admit failure. Further, while GST has not benefitted the country, the bigger challenge it presents is to fiscal federalism, which
has been dented and which will have long-term consequences. It needs to be tested whether GST also falls foul of the basic structure doctrine.
(Arun Kumar is a former professor of economics at JNU and author of Ground Scorching Tax. This is an abridged version of the article first published in The Leaflet)