OPINION | Macroeconomic implications of GST 2.0

GST has been the government’s star performer outpacing even nominal GDP with a CAGR of 17% over seven years.

The morphing of GST into a two-rate structure marks a major milestone in its brief career. Whether rate reduction counts as reform can be debated, but the rationale - making goods cheaper for the common man and boosting consumption and growth- is clear. The effective weighted average GST rate has reportedly declined from 14.4% at inception to 11.6% in 2019 and now to about 9.5% which may be perhaps be the optimal rate that maximises revenue, in a Laffer Curve sense. After all, GST has been the government’s star performer outpacing even nominal GDP with a CAGR of 17% over seven years.

The government estimates the net loss of revenue to be about Rs 48,000 crore which may not dent the fiscal deficit. The important issue is really about the impact on private consumption, the largest driver of growth. While government may ensure that tax cuts are passed on to consumers, they still need to take the bait of reduced prices.

‘Sin tax’ rate to offset potential revenue loss

The initial enthusiasm was fuelled by the belief that nearly all the 28% and 12% rated items will move down to 18% and 5% respectively. It did turn out that way with over 375 of 400 odd items moving to lower rates, notably mass consumption items (hair oil, toothpaste, butter, ghee) consumer durables (TVs, fridges, ACs etc) automobiles and two-wheelers.

But there were also a few surprises - garments, clothing, textile items, paper and paperboards moved up (12% to 18%); non-alcoholic beverages, soft drinks, aerated drinks etc attracted the new ‘sin’ tax rate of 40% and tax on coal went up from 5% to 18%. The government clarified that hikes were largely the result of merging compensation cess levy with GST to maintain tax incidence and will have no impact. But setting the ‘sin’ tax at a steep 40% is clear intent of raking in revenue to compensate the losses on rate cuts, especially looking at kind of items now added such as beverages, soft drinks, IPL tickets and high-priced movie tickets. Surprisingly, no major changes seem to have been made in services barring health insurance (reduced from 18% to nil), budget hotel stays and personal services such as gyms, salons, fitness where rates dropped from 12% and 18% to 5%.

Inadequacy of granular data

The hypothesis that tax cuts will lead to increased consumption, investment and GDP growth can be tested only if the impact of taxes on spending is known; this is difficult to assess due to the lack of reliable data on consumption, household incomes and tax revenue. There is no official data on GST revenue collected by commodity/service or even by rates which is puzzling. For a tax that had subsumed thirteen different taxes, the lack of transparency is inexplicable especially when the software calculates tax at a granular level.

But it is possible to derive taxes from consumption using Personal Final Consumption Expenditure (PFCE) data in national accounts and mapped to GST rates. But this can be hugely challenging as consumption data is not disaggregated enough (e.g spending on hotels & restaurants, personal transport expenses, house rentals, to name only a few) while GST rates are varied, with rates often differing for the same category based on end-use or value or even simply arbitrariness.

But surprisingly the mapping of the pre-September five-rate GST slabs to PFCE for 2023-24 yields an estimate that is reasonably close to actual gross tax revenue for 2023-24 (Rs.15.2 lakh crore). Even the shares of different rates seem to be in line with actuals.

Grouping the 46 items in PFCE data under four categories viz essentials, items of mass consumption, standard goods & services and luxury items makes it convenient to map the five tax rates to them. The estimated GST at Rs 14.8 lakh crore on total consumption of Rs 181.3 lakh crore works out to an effective rate of 11.9% (excluding zero-rated consumption).

Elasticity of demand in the sin tax category will make a difference

A striking aspect of both consumption and tax revenue is the skew- essentials and items of mass consumption account for over 50% of consumption but only about 12% of tax revenue.  Post September 22nd, the share in consumption is likely to rise further to over 60% as more items from 12% and 18% enter the zero rate. This has implications for both revenue and growth. Plugging in the new rates to the same PFCE data (i.e. without assuming any increased consumption) the loss of total revenue works to about Rs.1.1 lakh crore which is close to what the government estimates (Rs 93,000 crore).

But the government additionally hopes to raise Rs 45,000 crore from the new 40% “sin” tax rate which brings down net loss to Rs 48,000 crore.  This looks a strong assumption. For one, the sin tax increase is steep, from 28 to 40%; only if demand turns out to be inelastic as with tobacco, the rate increase could achieve the target. It also explains why so many new items such as beverages, soft drinks, aerated drinks, IPL and movie tickets have entered the 40% bracket. Also, luxury spending has always had a low share (3-4%) in total consumption. And with a two-rate system, the Government may have scraped the bottom of the revenue barrel. Rates on gold, silver, diamonds remain unchanged while petrol and diesel are unlikely to come under GST in the foreseeable future, which raises the question whether GST revenue can maintain its high growth rates.

Income may influence consumption more than tax rate

The growth implication of the consumption pattern is more important. The skewed spending pattern (over 50% of spending is on essentials and mass consumption items) is indicative of low incomes and high inequalities, though the shift to a two rate system seems to suggest that inequality is no longer an issue. For sure, tax cuts will leave more money with households and lower inflation but for overall consumption to move GDP, spending on essentials and mass consumption items needs to increase substantially.

These are more a function of incomes than tax rates. At the margin however, there could be increased demand as consumers shift from low-end to high-end products. The focus has mostly been on consumption but investment could also turn out to be a bright spot, especially construction activity with the substantial reduction in tax for cement, granite and building materials. Lower costs here could drive retail housing and infrastructure, both key components of gross fixed capital formation and power growth as much as increased consumption.

(SA Raghu is a columnist who writes on economics, banking and finance.)

Views are personal and do not represent the stand of this publication.