Media reports suggest that the GST Council is expected to increase rates to counter the shortfall in GST collections. At the same time, there is discussion that personal income taxes could be cut to counter the demand decline.
A GST rate increase will be contractionary for the economy, if it results in higher tax collections. A cut in income tax will be expansionary, and give a boost to consumption demand, which has been sluggish.
Since the two moves have different effects, and since they are based on a different diagnosis of the economic situation, they may counter each other and produce little or no result for the overall economy, while causing disruption in specific sectors. So, before the government decides to do either, it needs to take a view about the macroeconomic picture, about whether there needs to be a tax cut or a tax increase. Is this a time for fiscal expansion, or for fiscal consolidation?
Time to cut both together
In an economy, like in a human body, there are many factors at work, and it is difficult to quantify the overall effect of any intervention, such as a particular medicine or a tax cut. The problem will only get more complex if two medicines with opposite effects are given together.
Under the present business cycle conditions of the Indian economy, surely the government cannot believe that it is time for increasing taxes to reduce demand further. Indeed, it should be a time to talk about cutting tax rates to increase demand quickly, and faster than government spending can.
Cutting taxes puts money saved on taxes directly into the hands of consumers, which they can spend on other goods and services. From a macroeconomic stabilisation point of view, this is a time to cut both personal income taxes and indirect taxes. That would be the quickest way to push demand and try to correct the cyclical downturn in demand.
Will GST go the excise way?
It is not clear that increasing GST rates for some items is going to increase tax collections. We started with high rates, but because of the complications, we reduced them. Higher rates can also produce higher tax evasion.
When the present GST regime, with multiple and high rates was introduced, it was feared that the lack of simplicity in the system would create difficulties with compliance. What was not fully anticipated was the infinite appetite of the Indian bureaucrat for tinkering. Year after year, in response to various lobbies and short-falls in tax collections, officials exercised their power to change excise duty rates.
If anyone tries to make a list of the excise duty rates applicable on each item in each year for the last 30 years, it is nearly impossible. The rates change, the definitions change, what is exempted from taxation changes.
Is GST going to go the same way as excise went, with constant changes and no predictability? The whole purpose of the GST was to give the nation a simple, single tax rate that would improve compliance and bring the economy. What is the vision of policy makers for the GST? When is it expected to stabilise? Or, will it always be like a bunch of instruments, to be continuously tweaked, and never a set of stable rates?
Is the GST council meant to be like a monetary policy committee that is expected to look at GDP growth or tax collections, and to increase or reduce GST rates on various items?
Need clear policy direction
Even while one asks the question about what is the vision of the government’s economic policy team about the fiscal stance and role of the GST council, it is not clear that there is a consensus among policy makers with clarity on these issues. Tax officials always prefer more arbitrary power to less power.
If there is no clear position taken by the government to bind the hands of tax officials, if there is no clear-cut policy direction, they will always choose to tweak rates the way they used to do with excise.
This creates policy uncertainty and is bad for investment and growth. The government should begin with a white paper that clearly states its view on the present fiscal stance. Further, it should decide what should be the role of the GST Council and how the GST is expected to evolve over time.
If it is going to be forever changing, and that is the vision, we may never yield the benefits of the GST, and it may be time to go back to the drawing board.
The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.