Past experience tempers expectations of GST reform gains, while current economic conditions and demand support could influence short-run growth impact.

Infrastructure investments support growth both in the short- and long-run; other reforms might be more state-dependent. Photo: Pradeep Gaur/Mint

A single goods and services tax, or GST, is now on course for introduction from the next fiscal year. Various aspects of this reform, chiefly its final form—a multiple-rate structure, altogether four slabs plus a cess, an exempted class and another rate for gold—have attracted a lot of comment and criticism. Several have argued these distortions will lower expected additions to growth, estimated in the 1.5-2 percentage point region, by reducing the extent of improvements to efficiency and productivity.

Acknowledging the political economy considerations underlying these added complexities, most still expect payoffs from this structural reform. Simplification, to start with, is the biggest gain: a single tax on goods and services will now apply nationally, instead of a multitude of different taxes, tariffs and rates across the centre and the states. Better compliance and base-widening from an input-credit based consumption tax is another. And less costly, time-consuming and hassle-free inter-state transportation of goods is another benefit.

Altogether the hope is that indirect revenues will increase. Given that inflation fears have also governed the selection of multiple tax rates, the likelihood of price increases from this structural shift is nearly zero. The economy as a whole will operate more efficiently. In the process, businesses and associated services will presumably undergo some restructuring, reallocating resources and creating new opportunities as result. Newer business avenues may separately arise too.

The focus ahead therefore has to be on the growth and productivity impact of the GST reform. Being a structural reform, growth and productivity effects of GST will be observed only in the medium- to long-term. Two issues merit noting nonetheless. The first is from past experience with taxation reforms, i.e. replacement of the sales tax system by the value-added tax (VAT), bringing the untaxed services sector into the tax fold and changes in tax administration, organization and enforcement-monitoring practices to raise compliance and reduce evasions. Net combined gains from these past reforms haven’t been too substantial as the tax to gross domestic product (GDP) ratio or the additional increase in revenues in relation to nominal GDP is just about 2 percentage points higher on average in the post-2000 period compared to the preceding decade. India’s structural revenue-expenditure gap persists and weighs on public balances and the country lags behind its emerging market peers in this regard.

Gains from past structural reforms in taxation have been quite low. Perhaps, these could have been bettered, and can be done now if only past experiences illuminate the present. This also brings in the second point when considering growth payoffs from structural reforms. Over the medium- to long-term, functional improvements are a potential source of productivity enhancement for surely there is little doubt the Indian taxation system needs an overhaul. In addition, the state of the economy matters as well when reckoning the productivity-growth payoffs from structural reforms according to the International Monetary Fund’s recent appraisal. For example, infrastructure investments support growth both in the short- and long-run; other reforms might be more state-dependent. Then, demand support is critical for the success of some structural reform efforts; brightening economic prospects boost growth effects and can also offset short-term costs.

So while the long-term benefits of the GST aren’t in doubt, it remains to be seen if this reform is likely to boost growth even in the short-run or could even be a drag on that. The Indian business cycle is commonly held to be operating below trend at the current juncture, but is expected to strengthen steadily ahead.