Prime Minister Narendra Modi’s government is once again making waves by altering the Goods
and Services Tax, or GST. Modi’s government will be reforming the GST four-slab tax system
into two respectable rates, 5% and 18%, all while reducing the costs of several assets, including
cars and appliances, and even regular necessities. In principle, this sounds good for the
economy and regular people. However, a deeper analysis hints at various complexities of
benefits and risks that will have both political and economic ramifications and very well may not
simply resolve as the government articulates.
The Political Game
The politics of the reform are quite obvious. A tax reduction is a bold step and enormously
popular. By committing to lower the price of almost everything, from two-wheelers to air
conditioners to cement, the government can present itself as a friend of ‘the people’. It’s easy to
understand: we are saving you money and making your life easier. The timing is also propitious
for creating some public goodwill prior to significant upcoming elections. It creates a narrative of
a big win for the people, and it helps to quietly resolve some of the issues that occurred when
GST was originally implemented.
The previous GST was widely derided as too complex (especially for small businesses) and
really high rates of tax on many commodities. This new plan is an opportunity to recover trust,
and quiet critics. It is a remarkable offer to voters, and a clever way to change the subject from
poor previous amendments and to draw attention to a more pleasing future. The intent to make
the tax system simpler to administer and make more sense appears to be a direct response to
public demand, and it will certainly earn the ruling party valuable political capital.
Economic Uncertainty
While the political advantages are easy to see, the economic picture is more mixed and comes
with uncertainty. The basic premise is that lower prices will lead to additional purchases. It is
expected that increased purchases will compensate for any tax revenue lost through the rate
cuts. However, not all economists are convinced. Some believe the shifts could result in a
massive hole in government revenue with estimates in some cases pointing to the hundreds of
billions of rupees lost each year in tax revenue, which will create serious issues to finance the
central government and the states. The potential loss of revenue is also a serious layer of
complexity to an already difficult challenge: the relationship between the central government and
the states. When GST was brought into place, states relinquished their power to collect tax on
gross sales of most products, with an agreement from the central government of reimbursement
for whatever amounts the states lost.
This promise has been about tension and disagreement. Many states are now concerned
post-reform that they will ultimately get less money, and also have more dependence on central
government fiscal capacity. This too will likely repair the tensions and generate emerging
conflicts and a further breakdown over the states’ authority to deal with their own money. The
GST Council, where all our industry decisions about GST are made, will provide a new focus for
tension around GST. The reform may gain some political popularity but will also generate
ongoing significant economic problems and likely new divisions and even conflicts between
central and state governments.
The Long-Term Impact
There are other challenges alongside a simpler tax system. The government hopes the two-slab
tax system will allow smaller businesses to comply and pay taxes easier. However, GST was
introduced in a way that was supposed to be simple, and the first year was really largely
different. Smaller businesses had to manage many problems and incurred significant costs to
ensure compliance with the system. The government will have to prove this new tax system is
not just more complex with a new name, but will also have to make up for lost revenue. If the
government cut spending on other governmental programs or capital projects to make up the
revenue, taxes were cut, and the tax cut is not what is better for the economy. Though a simple
tax structure is desirable, it is also equally important that a clear plan is developed to figure out
the real-life outcomes.
Ultimately, this GST overhaul is a bold step forward. This really gives the economy and a overall
good news for the people. It is designed to enhance spending, simplify the tax system, and
influence the opinion of voters. However, it also brings actual risks, including major reductions in
government revenues, increased tension between the central government and states, and
additional pressure on public spending. How well the government negotiates these risks will
determine the impact of this change. Whether a real economic win or just a political win, time
will tell.