GST Rate Cut: Exuberance and Reality
Sanjay Roy
THE recent rationalisation of GST rates seems to be a sigh of relief to consumers as well as to producers after facing a tyranny of cumbersome tax regime for eight long years since the introduction of GST in 2017. Indirect taxes are generally insensitive to incomes and wealth of people and so a reduction in tax rate is equally beneficial to all because in absolute terms the amount of money saved for all units of goods and services are equal for all but the relief of the burden would be more to people who used to spend larger proportion of their incomes on consumption, that is the poor and the middle class while the relief in relative terms is lower for the rich who spends comparatively less in consumption out of their total incomes. Based on the same logic the burden of higher rates on consumer goods and services was disproportionately more upon the poor and middle class compared to the rich for the past eight years. Ironically the celebration in the press on the rate cut is symmetrical to the exuberance expressed during the introduction of GST eight years back. People of this country had to pay higher taxes; small businesses had to bear huge compliance costs and informal sector couldn’t take advantage of the value added tax since their value addition is kept completely invisible. Let’s not forget the demonetisation which preceded the tax reform that completely threw the entire informal sector and small producers out of the grid. Production and business suffered for the past eight years and now a rate cut might bring some relief in terms of lower prices. There are different estimates of revenue loss but without going into contesting figures the core belief that the government holds are the following. With expected decline in prices disposable income of consumers are expected to rise hence they will buy more consumer goods and services, and such augmented purchase would increase further mobilisation of GST revenues which would reduce the revenue loss due to the rate cut.
RATE CUT AND CONSUMERS’ RELIEF
Undoubtedly a cut in GST rates for about 400 items is going to reduce prices. But this also depends upon how producers respond to the rate cuts. The producers would be inclined to pass on the entire amount of reduction in tax to the consumer by reducing the sale price exactly equal to the tax amount depending on the extent of responsiveness of consumers to a fall in price. Now there are commodities where a decline in price leads to more than proportionate increase in demand for that product. In that case the producer might be interested to transfer whole of the tax relief to the consumer because even if unit price of the product falls as the rise in demand would be proportionately more, the revenue earning of the seller net of tax would be higher than the previous scenario. This may be the case for items of goods or services that are not necessaries. On the other hand, there are goods and services for which the rise in demand would be less than proportionate to the fall in prices. For instance, price falls by 10 per cent but due to the fall in price the demand increases only by say 2 or 3 per cent. In those cases, the producer may not transfer the entire benefit of tax cut to the consumer, instead may think of increasing per unit profit. Also, the extent of transfer of benefit to the consumer will depend upon how in the changed scenario producers are able to realise input tax credit claims. For instance, premium for individual health insurance is likely to rise even if applicable GST rate is being reduced as insurance companies would not be able to claim any input tax credit for operational services such as TPA, administration fees and IT related services. In other words, the outcome in prices for different goods and services are yet to be seen.
Also, for some items consumption may not increase in quantity as a response to fall in price rather consumers are likely to shift to higher quality or higher value-added product in the same segment due to higher disposable income. This would move consumers more towards branded products. It is well known that within the GST system the claim of input tax credit that is claiming the tax already paid while purchasing the inputs is only possible for registered units within the formal sector. The tax burden in this kind of a regime is relatively much higher for the small or tiny unregistered producers who cannot claim input tax credit. In case of India largest share of operating enterprises belong to the informal sector and they would not be benefitted due to the rate cut. On top of that they would be in a disadvantageous situation vis-à-vis formal enterprises as they would not be able to claim the tax already paid during the purchase of inputs.
Most importantly the tax rate has been increased for coal from 5 per cent to 18 per cent and this is going to increase production costs of electricity and since electricity is not under GST so no input credit can be claimed on enhanced input price of electricity. Also, the GST rate on transportation of oil through pipeline and job works related to exploration and production on oil has been increased. Again, since fuel is not under GST the rise in tax burden of these services cannot be claimed as input tax credit. Now both electricity and fuel prices are likely to increase which would surely have cascading effects across the economy offsetting some of the gains of tax cuts in other sectors. Also, as in many cases the tax rate on the final product will be less than the tax rates on inputs or intermediate goods and services, giving rise to what is known as inverted duty structure. In this case producers must put more money initially paying for the high taxed inputs and struggle for input credits later. This will force producers to spend more initially making small producers cash strapped as they do not have big pockets or easy access to credit.
CONSEQUENCES OF REVENUE LOSS
The announcement of GST rate cuts might have some link with the announcement of punitive tariffs of additional 25 per cent imposed on exports to the US. Expecting a decline in export demand the government might have thought of jacking up domestic demand by GST rate cut. There is genuine reason to believe that a fall in prices as expected would increase domestic demand but how households would respond depends on their current financial health. The consumption growth in recent decades is largely credit driven. Consumption expenditure data also shows that reliance on micro credit and EMI has increased significantly for Indian households both in rural and urban areas across classes. According to the figures of National Statistical Office gross financial savings of household as percentage of GDP remained stable in the past decade but the ratio of financial liabilities to gross financial savings increased sharply leading to a decline in the net financial savings to GDP ratio. This simply reflects the fact that credit driven consumption is reaching its limits. As real wages remained stagnant for a long period marked with episodes of decline together with a dampening employment scenario even a fall in price may not trigger significant rise in consumption demand. The Chief Economic Adviser anticipates that the fall in GST rates and consequent lowering of prices may result in a nominal GDP, at the end of the current financial year, less than what has been estimated in the budget. This implicitly assumes that the growth of demand is likely to be proportionately less than the fall in prices. The government has estimated a revenue loss of Rs 48,000 crore because of the GST rate cut. It is for sure that this will not be made up by taxing the rich. Also, this is going to reduce revenue mobilisation for the states who share the responsibilities of most of the central welfare schemes. Therefore, given the revenue loss and to keep the fiscal deficit in order, the government is likely to cut public expenditure particularly on subsidies and welfare schemes. Hence the expected fall in prices and a bonanza for the consumers is going to turn against the poor. Those who are relatively well placed with stable incomes and secured jobs would have higher disposable incomes, big producers would gain by capturing larger part of the market but majority of the households who are already facing rising liabilities of past credits would hardly consume more and finally the poor would be facing the pressure of expenditure cut, in the near future.
