The challenge for 2019 is to push up the growth rate fromthe present seven per cent. Economic growth is basically driven by demand.There is demand for cloth and cement in the market if people have the money tobuy garments and build houses. This demand leads to an increase in prices ofgarments and cement and makes it profitable for the businesses to invest in newtextile mills and cement factories. These factories create employment. Workersare paid wages with which they buy more garments and build more houses. In thisway a virtuous cycle of demand and investment is put into motion. This virtuouscycle is presently broken by GST in two ways. One, the Medium, Small and MicroEnterprises (MSMEs) have come under stress and less employment in being createdand there is less demand in the market. Two, the move towards a single rate ofGST will increase the tax burden on the poor and lead to a reduction in demand.
According to the Annual Report of Ministry of MSME, theshare of MSME in GDP was 29.6 per cent in 2011-12. It declined to 28.8 per centin 2015-16. The MSMEs are creating bulk of the employment in the country.According to the Ministry of MSME, the employment generated by MSMEs in 2015-16was 11.2 crores. In comparison, according to the Economic Survey published bythe Ministry of Finance, the employment generated by the (Large) Private Sectorwas only 1.2 crores in 2012-13. Thus, MSMEs are generating ten times theemployment created by large industries. The weakness of MSMEs, therefore, hastranslated into fewer jobs, lesser demand and broken the virtuous cycle ofdemand and investment.
The GST appears to have led to a further deterioration inthe share of MSMEs in GDP—which was already sliding earlier as above dataindicate. This is a global trend. A study by Victoria University found thatMSMEs in Australia spent 3 per cent of their total revenue in making compliancewith the GST—that is about one-third of the profits earned by them. Five out ofsix MSMEs said that their condition was worse than earlier. A study by theUniversity of Wellington found that the distributional impact of the GST onMSMEs in New Zealand slightly regressive—meaning a higher tax burden on them. Astudy by Monash University in Malaysia found that the some MSMEs “voiced theirconcerns over the closure of small or traditional businesses, mainly due totheir inability to manage the GST requirements, coupled with anxiety and fear(psychological costs) over the costs of non-compliance.” Similar studies areavailable from Norway, Singapore and the European Union. Anecdotal evidencesuggests that the situation in India is similar, if not worse. There is a needfor the government to rescue the MSMEs from this decline otherwise thereduction in employment will become a social disaster in addition to aneconomic one. The government must allow the MSMEs to obtain refund of the GSTpaid on inputs even if they pay only 1 per cent GST on the sale under theComposition Scheme. Secondly, the government must allow MSMEs to pay GST whenthe customer makes the payment, not when the MSME raises the bill.
The government proposes to merge the multiple GST rates intoone single rate so that tax administration becomes simple, businesses have lessdifficulties in compliance, the economy becomes smooth and growth rates picksup. A single rate of GST means that Mercedes and milk will be charged at thesame rate. Till now we have taxed the goods consumed by the rich such asMercedes car at a higher rate, and goods consumed by the poor such as milk at alower rate. Thinking was that the poor will have more cash left in their handsand their welfare will be protected. There is also an economic dimension to thedifferent rates of GST. Let us say Ratan Tata loses Rs 1000 from his wallet.His consumption will hardly be affected. But, if a peanut seller loses Rs 1000,he will immediately have to cut his consumption of shoes, cloth or milk. Asingle rate of GST will lead to a reduction in the tax burden on the rich withno increase in consumption by them, and an increase in tax burden on the poorand a reduction of consumption by them. The total consumption will decline and,once again, break the virtuous cycle of increased demand and investment.
We are caught between two contrary impacts of the singlerate of GST. On the one hand it will simplify the tax administration and leadto higher rate of growth. On the other hand, it will lead to increased taxburden on the poor and to lower rate of growth. This problem has beenconfronted in many countries that have wanted to move to a single GST rate. Astudy by the Inland Revenue Department and the New Zealand Treasury says thatlower rates of GST on goods consumed by the poor indeed leads to lower tax burdenon them but “welfare transfers are generally considered a more targeted andsimpler way of addressing distributional concerns.” A study for the UnitedKingdom done by Nobel Laureate James Mirrlees concluded that “the poor would bemuch better supported if the government were to remove the lower tiers of VATon various items that the poor consumed, and instead help the poor moredirectly instead.” A study for Botswana done by Sheridan College, Australia andUniversity of Canterbury, New Zealand suggested that Botswana should adopt asingle rate of GST and “consider introducing income supplements and welfarepayments” in order to assist the poor for the increased burden of tax. These,along with other studies from across the world, suggest that the way toreconcile single rate of GST with equity is to simultaneously introduce directbenefit transfers in cash to the poor. Such transfers would prevent a reductionin demand due to the increased burden of tax on the poor. The finance ministeris on the right track in moving towards a single rate of GST but theprecondition of its success depends on simultaneously introducing direct cashtransfers to the poor.
The challenge for 2019 is to bring the economy back on to ahigh growth rate. The government should immediately allow MSMEs to get cashrefunds of GST paid by them on the inputs and to pay GST when they receivepayments. This will revive the MSMEs, create employment and demand. Two, thegovernment must institute direct cash transfers to the poor and only then moveto a single rate of GST. That too will maintain, if not revive, demand andunleash a virtuous cycle of demand and investment leading India to double digitgrowth rates.
Bharat Jhunjhunwala was former Professor of Economics at IIM Bangalore.
