GST: A structural reform towards a unified market
Five years since its roll-out, GST has created a united nationwide market. The next five years should be focused on deeper formalisation, removing credit extension asymmetries, and becoming a model for constructive cooperation
The Goods and Services Tax (GST) is now five years old. It was first envisioned around two decades ago, but was implemented only in 2017. Like many actual big bang reforms such as privatisation or an open capital account, this too was not an event but a process, one which remains a work in progress. GST was never just an economic reform, but also a constitutional, political and technological one.
The GST Council, comprising the states and the Union government, was created and dozens of laws, taxes and cesses were merged to create GST. There is now an input tax credit mechanism for inter-state trade to finally create a unified, nationwide market.
The states never had the power to charge service tax and GST gave them that.
Nonetheless, the revenue-raising autonomy of individual states has been reduced, and this may be an emerging political-economic issue given that the five-year compensation window is ending, though a decision on its extension has not been made yet.
Today there are around 14 million Gst-paying entities, about four million of which use e-way bills. Almost half of such bills have been for inter-state commerce. Monthly collections have increased from less than ₹1 lakh crore to around ₹1.5 lakh crore, with April 2022 recording ₹1.68 lakh crore. Between FY18 and FY22, compounded annual growth rate in average monthly collections has been north of 8% on a net basis despite significant tax cuts and a global pandemic. Many state border check posts are now redundant, helping cut notoriously high logistical costs as well as reducing corruption. Small and medium businesses have had appropriate threshold limits to balance compliance with ease of doing business, though this remains a tricky trade-off given that many micro, small, and medium enterprises (MSMES) were earlier not in the formal economy.
While small thoughtful steps such as the refund of accumulated input tax credit to exporters are welcome, more cross-netting of input tax credits across states for companies is also needed. Further steps, such as automating form completion and reducing filing frequency, especially for smaller businesses, are needed to ensure that the erstwhile cash-economy enterprises which are joining the formal economy and paying taxes do not face heavy compliance burdens. The formalisation of businesses is being catalysed by a cohesive bouquet of government policies, with GST among the principal drivers. Despite its flaws, the new indirect tax regime is a huge improvement over the status quo ante. Overall, around nine in 10 Indian chief experience officers, across key sectors, have backed GST fully or partially, as per a recent Deloitte survey.
Looking forward, the linking of GST data with the account aggregator ecosystem will enable cash flow-based lending for MSMES in addition to traditional asset-backed lending options. Credit extension to India’s 60 million MSMES has been a longstanding pain point, with the gap estimated to be about ₹20 lakh crore. This deprivation of credit has downstream second order effects of reducing job creation and growth potential. The GST data set will bridge a critical information asymmetry for lenders evaluating the creditworthiness of MSMES -- armed with GST data, they will have less need for collateral and will be able to offer bespoke lending rates and solutions as per the data trail.
On the question of the number of rates or GST slabs, further rationalisation is required, even if having one rate would be too impractical in India where the penetration of direct taxation is limited to a small demographic, and hence fairness requirements have to play out on the indirect tax front as well. But this should not become an excuse for micro-management of rates and items as some memes on social media rightly, if somewhat harshly, point out.
Going forward, states being guaranteed compensation will set the wrong precedent as it would take away incentives to ensure proper compliance and promote formalisation. Even so, some kind of compromise can be reached whereby a floor is guaranteed without the egregious year-on-year increase guarantees.
The original rationale for bringing GST was to rightly prevent a cascading of taxes; with this in place, being bigger, but in the tax net, makes more sense for entrepreneurs rather than being small and working with what can euphemistically be called regulatory tax arbitrage. For the next five years, GST will provide the foundation to achieve deeper formalisation (helping the government grow the tax net and creating space for structural reforms in direct taxes), erase information asymmetries in credit extension (aiding in job creation and economic growth) and finally, serve as a model for constructive cooperation between the Union government and the states.