A social contract for economic recovery
The case for cooperation on GST
Two heads are better than one, right? Yes, if both work towards shared goals, and one’s gains are not the other’s losses. This is why businesses cooperate. So could the government, industry and consumers, if governments — Central and states — choose to do so. Prospects can improve provided there are overall gains, and all boats rise with the tide. Problems arise if the costs of cooperation are high, or if one participant makes net losses, or considers its share inequitable.
Economic reality and society’s economic contract (echoing Rousseau) have this triad of government, industry (products and services), and consumers, influenced by the media and the judiciary. A coordinated approach could help in resolving impediments to economic recovery. Consider as an example the goods and services tax (GST) rates on products and services. For any rate, government collections increase as product/service delivery increases. However, demand usually declines with increasing prices (including GST). The market equilibrium will be at some level of user-perceived value, at a price depending on supply and demand levels. Conversely, lower GST rates mean lower prices, and higher demand. For expensive products, the lower the rates, down to a reasonable level, the higher the government collections from GST, barring implementation problems. This is because as the tax rate increases, beyond some level sales revenues will decline, as will GST collections.
While government treasuries focus on tax collection, governments’ objective, aside from staying in power, is (or should be) to maximise public benefit. When taxes collected are (a) reasonable, and (b) contribute to the common good, they combine with the user’s perceived value of goods and services at the prices paid, as a component of public welfare flowing from government funds. There is conceivably an optimal GST rate for a product/service that maximises the public benefit for a society, given its circumstances and priorities. These tax rates influence key areas of manufacturing and essential services. Consider an example from each.
India’s capacity in manufacturing cars and automotive components has been built up systematically over many years. In 2018, exports amounted to a little over 5 per cent of total exports of $323 billion, of which components were about 2 per cent, with strong prospects. However, sales slowed for various reasons, some relating to the difficulties of transitioning to the GST system, including the technical challenges. Earlier, domestic taxes were higher, and GST on vehicles and components at 28 per cent was a reduction assumed to yield higher revenues. However, severe GST system design and implementation problems compounded by disruption because of new technologies (electric vehicles), stricter pollution controls (BSVI), confusion about diesel regulation, and a slowing economy, resulted in declining sales from July 2018 (see chart). Difficulties with the GST systems also affected exports.
There are three aspects to consider regarding GST rates:
First, the likely effect on revenues if taxes are lowered n from 28 to 12, or 5 per cent.
a) The market leader Maruti Suzuki is unlikely to be affected by a high GST rate because of temporarily slowing sales, as it has installed capacity from prior investment. Major international manufacturers who have not yet established a solid manufacturing base for the domestic market and for exports, however, are likely to have different financial compulsions. Even if they expect that India will be a substantial market and a sound manufacturing base in 10 years or more, the fact that the interim period is fraught with regulatory uncertainty and infrastructural inadequacies may considerably dampen their enthusiasm, to the point of considering alternative manufacturing locations. India cannot assume that it is the alternative to China by default. Major manufacturing investments require stable policies, and low, stable tax rates help in building cash flows.
b) India’s experience with telecom franchise fees after 2003-04 shows that a significant reduction in revenue share from operators, from 15 per cent to 8 per cent, along with other factors enabled explosive growth. These resulted in much higher government collections (compare ~20,000 crore foregone over eight years in auction fees until 2006-07, to nearly ~35,000 crore collected in five years from the rate reduction until 2006-07, which then increased to over ~1,65,000 crore by March 2015).
Second, automotive exports need a sound domestic market. Slowing domestic sales and cash flows can affect export markets, compelling foreign buyers to seek alternative manufacturing sources. This can further constrain domestic parts manufacturers who rely on linkages with their customers to build their brands and order books.
Third, the effect of lost sales on employment is devastating, because this sector provides direct and indirect jobs to many millions.
Similar reasoning applies to government charges on digital infrastructure for telecom services, considering these charges amount to more than the investment in networks. Misplaced policies for resource allocation and pricing, misplaced zeal in enforcing questionable interpretations of the law, as well as selective preferential/unfair treatment, have crippled these essential services. Ill-conceived litigation by successive governments have seriously constrained India’s productive capacity, and will continue to do so if pursued. Instead, well-formulated policies, and pricing in the public interest, could lead to a vibrant sector, with a more effective digital broadband network for countrywide productivity and better living conditions.
Our governments can choose to work with industry and users for better outcomes, instead of contending on the basis of outmoded mindsets, laws, and regulations. It requires a far more constructive attitude than has prevailed so far, and an honest recognition of what we lack: Institutional support for organisation and management, including a systems approach, disciplined, end-to-end processes (starting with timely government payments), professional facilitation, legal rigour,1 expert financial modelling and simulation as decision support, and so on, over considerable time.
Administrative authorities and the political leadership need to exert themselves to pull all this together systematically, with the logic of cooperation as the basis of an economic contract.