Wait and watch on GST impact

A change as large as this means projections could be plain wrong

The Goods and Services Tax (GST) is a big and long-term bet, altering the economic landscape. In the old system, excise collections amounted to 3 per cent of gross domestic product (GDP) or 16 per cent of gross central tax collections. Service tax generated another 2.5 per cent or 15 per cent. Excise collection of states was 2.25 per cent. The big bet is that GST will generate as much, or more, than all these taxes combined. Alcohol and petroleum products are outside GST. So, state excise will also generate significant revenues. There are many ways to hit revenue parity targets. The chosen route is a relatively high rate-structure, which tries to achieve parity as fast as possible. 

The Centre has adopted a complicated tax structure due to political expediency. Most successful GST systems work on few rates, ranging from one to four slabs. India has six, plus cesses, amounting to at least 11 different effective slabs, if I've got my calculations right. 

The logic for a high rate structure is that businesses get offsets. Every business on a value chain pays less tax due to offsets. But, since all pay, more revenue is collected. At the same time, barriers between states drop, making inter-state trade easier. That’s the selling point for GST, and the assumptions of faster gross domestic product (GDP) growth are based on that. 

In a high-rate structure, the end-consumer could pay more since he/she doesn’t get offsets. The speed of offset credits is also vital. Indian business works on very thin margins and long credit lines.  If tax offsets are slow, working capital costs will rise, maybe to a point where stress causes collapse of firms. Another problem is insane paperwork, with weekly reports and other filings, which will be a big barrier to doing business.  

As said above, gains come from assumptions that goods will be transported more easily inter-state, cutting down logistics costs. But, state excise machinery will implement GST and state excise remains on items. So physical checkpoints won’t disappear. Long lines of trucks at state borders will continue to be a logistical nightmare even if inter-state tax rates equalise. In services, small businesses in design, advertising, software/hardware support, other repair and maintenance, etc, will find it hard to cope due to the paperwork blitz. An estimated 500,000 data entry operators will be required to run the GST system. The GST Network  authority is opaque. So, we have no means of knowing how efficiently it will function or what error-correction mechanisms it has. Also, provisions like anti-profiteering allow, and perhaps encourage, officers to extort. 

Given all this and sheer scale, things will be chaotic for a while. Any earnings and revenue projections are guesswork, with huge error margins, for at least two quarters. Projections on government revenue collections, including corporate tax, are also guesswork. Corporate tax is 32 per cent of all central tax revenues and more than excise and service tax combined. And, low profits mean lower taxes.  

The unorganised sector doesn’t gets offsets and, therefore, becomes tax-inefficient. Most businesses have a mix of organised/unorganised elements in value chains. Over 80 per cent of employment is in the unorganised sector. The hit taken by this sector will inevitably affect the organised sector. Businesses will migrate from unorganised to organised and that’s good. But, it won’t be an orderly process and there will be job losses. 

Analysts must wait and watch. If corporate earnings take a hit, and some sectors certainly will, investors must wait. Many kinks will have to be ironed out before the benefits of GST appear. The tax structure must rationalise; paperwork must reduce; the anti-profiteering clause will have to go. I haven’t seen any guesstimates on how long the system will take to settle. European GSTs averaged a couple of financial years. India has a much more complex tax structure and a less efficient bureaucracy. But, it probably has better information technology systems. 

Analysts and investors tend to make linear or semi-linear earnings and revenue assumptions. Good businesses have predictability. But, a change as large as this in the commercial environment means such projections will be plain wrong. There is a big potential upside but there may be a big downside, too.