GST-Losing Political Capital On An Over-Hyped Concept

With Parliament seemingly headed for a special session on the Goods and Services Tax (GST), we try to delineate the economic impact of this misunderstood tax. GST, at the revenue neutral rate (RNR) of 18%, will benefit most goods, as currently most goods pay tax at ~24%. However, an 18% GST is unlikely to boost GDP growth. In contrast, a GST rate of 25% will adversely impact consumption (of Goods & Services) but will boost Government revenues, which will in turn aid economic growth if the extra revenue is spent on capex. The final layer of complication arises from the 1% inter-state tax payable to producer states; if charged, this will reduce the benefits of a uniform GST. 

Evidence suggests that GST has a mixed economic impact Cross-country evidence suggests that the introduction of GST has no correlation with GDP growth. Although the introduction of a single GST limits inefficiencies created by a heterogeneous taxation system, there is little evidence that it helps boost economic activity. However, the introduction of GST helps in reducing inflation by removing the problem of dual taxation and thereby reducing the cost of doing business. It also helps in boosting the tax:GDP ratio, provided the GST is introduced at a high enough rate i.e., higher than the revenue neutral rate (RNR), which in India seems to around 18%. 

The structure of GST will determine the impact on the economy Whilst the introduction of GST will undoubtedly remove inefficiencies (such as the problem of double taxation) and simplify the existing indirect tax structure, its impact on economic growth is ambiguous. At the RNR of 18%, the Government’s revenue will remain unaffected and hence the Government cannot increase expenditure to stimulate growth; however, at a GST of 25%, India’s tax:GDP ratio (which at 11% is significantly lower than other emerging Asian economies’ >20%) will increase by as much by 1-2% points. If the Government spends these increased revenues of around $20-40bn on capex, then GDP growth will be positively impacted, especially as the fiscal multiplier (around 2.45x for India) comes into play. A further complication is the mooted 1% inter-state tax, which is supposed to be given to producing states; if levied, this can significantly reduce the benefits of moving to a harmonised GST. Note further that given the sheer amount of legislative and logistical work that remains to be done, it is highly unlikely that GST will be implemented before April 2017. 

Services stand to lose the most with the implementation of GST If GST is set at the RNR of 18%, most goods which currently pay an effective tax rate of ~24% will benefit. Sectors such as automobiles, FMCG and home building materials in particular will be positively affected. At a rate of 25%, however, most goods will be negatively impacted; however, at this rate Government revenue and, hopefully, Government spend on hard asset creation will receive a boost and thus drive GDP growth.  However, at both rates – 18% and 25% – Services will be negatively impacted, as Services are currently taxed at 14%. In the context of listed stocks, the Services sectors that will be most acutely impacted are aviation, media, telecommunication and to some extent Banking & Financial Services.