Calcutta Notebook


The Indian economy is slowing down. Prime Minister Modi recently held a meeting with top industrialists of the country to find ways of reviving the economy. One suggestion made by the industrialists was to speedily implement the Goods and Services Tax (GST). It is true that implementation of GST will make it easier to undertake interstate trade. The cost of shipping goods from Maharashtra to Gujarat would be reduced. The growth rate of the economy will increase. But whether Modi may take hit because voters will not like this.

The Government in Australia has proposed to increase the rates of GST from the presently applicable 10 percent to 15 percent; and to bring services such as those of health and education, and fresh food items under the GST. These were exempted till now. The leader of Opposition attacked these proposals saying, "you increase the GST, you increase the number of products it applies to, you hit poorer people hardest." Reason is that the poor use more of their incomes for consumption. A poor household may earn Rs 8,000 per month and use Rs 7,500 for housing, food and clothing. An increase in GST of, say, five percent, would mean an additional payment of Rs 375 per month by it. This would be about five percent of the household income. On the other hand, an upper class person may earn Rs 10 lacs per month and spend two lac rupees on consumption. He would pay an additional tax of Rs 10,000 due to increase in rates of GST. This would amount to only one percent of his income. The poor will pay five percent more taxes while the rich will pay only one percent more. The 375 rupees paid by the poor household will create much greater pain in the family than the 10,000 rupees paid by the rich household. A similar debate is raging in Malaysia where GST was implemented recently. Survey by a Malaysian newspaper indicated that families earning more than 12,000 ringgit were positive about GST while those earning below 5,000 ringgit were mostly unhappy with it. One person who was surveyed said, "The government wants to tax us and tells us to save. But then it goes and buys a new private jet."

Studies by government institutes in India paint an opposite picture, however. The Task Force constituted by the Thirteenth Finance Commission has concluded that GST will be beneficial for the poor. But the study is grossly flawed. It says that the poor will be benefited from a reduction in prices of manufactured goods, textiles in particular. It is true that the price of all textiles produced in the country may decline. But that does not mean that price of textiles consumed by the poor will decline. Presently, many goods that are consumed mainly by the poor such as coarse cloth, bicycle tires and rubber slippers are taxed at lower rates. Taxes imposed on these goods will increase in the GST regime. The prices of goods consumed by the poor will, therefore, face two opposite effects. Their prices will decline due to the overall improvement in efficiency but the same prices will increase due to higher rates of taxes imposed on these items. The Task Force has remained surprisingly silent on this issue.

The Task Force has recommended that the exemption of Rs 1.5 crore in excise duty that is presently available to small industries be removed. This will hit lacs of small industries hard. These industries are the major employers today. Many will close down leading to a huge loss of employment. Most amusingly, the Task Force has simultaneously assumed that full employment is prevalent in the economy. This assumption is total rubbish. Unemployment will certainly increase due to the implementation of GST.

The Task Force has said that the value of goods produced by a worker will increase by around one percent. A worker who is presently producing Rs 100 worth of goods will produce Rs 101 worth of goods after GST is implemented because the economy will become efficient. The Task Force concluded from this that wage rate will increase by one percent. This is, again, rubbish. The wage rates are determined mainly by supply and demand; not by the amount of goods produced. A factory may install an automatic machine and that will lead to an increase in the production made by the worker. But wages will not increase because other unemployed persons will be more than happy to work at the previous wage rates. Another study by National Council of Applied Economic Research has similarly made many false assumptions and concluded that GST will lead to enhanced welfare. The Government is trying to implement GST on the basis of these false studies. The professors who have done these studies will surely make good money but Modi may well lose his job because of the backlash from the voters!

It is suggested in economic literature that a reduction in rates of income tax could compensate for the negative impact of GST on the poor. This will not work in India since most workers are employed in the informal sector and pay no income tax. Another suggestion is that subsidies such as those on food grains could be increased and targeted towards the poor. This will be self-defeating. The purpose of GST is to make the economy efficient. It is well known that welfare programmes are hugely inefficient with problems like that of bogus ration cards being endemic. The increase in efficiency from introduction of GST will, therefore, be cancelled by decrease in efficiency in the welfare programmes.

That said GST has its positive aspects. It will lead to an increase in taxes on consumption and a corresponding decrease in taxes on incomes. But this comes with a caveat, however. The reduction in consumption should be of the rich, not of the poor. Need is to increase the taxes on consumption on items such as cars, flat screen TVs, smart mobile phones and the like; and reduction in taxes on items mainly consumed by the poor such as bicycle tires and rail travel in second class. The GST regime does not make a distinction between consumption by the poor and the rich. It is like asking the malnourished poor fellow to compete with the well fed goon of the landlord and is harmful for the poor. Modi must not be carried away by the business looby and take a hard look at the impact of GST on the people of the country before moving fast forward on this issue.

Vol. 48, No. 13, Oct 4 - 10, 2015