Arun Kumar
The move’s adverse impact on the unorganised sector is likely to overwhelm its positive impact on the organised sector.
The GST rate reduction on a large number of items seems appropriate. The GST Council unanimously agreed to this major rationalisation of rates at its meeting on September 3. The opposition-ruled states worried about revenue loss could not oppose the rate cuts since it would have been politically inopportune to do so given the perception that these cuts would benefit the common person.
If these cuts are beneficial, why were they not implemented earlier? It has been known that GST is an indirect tax and is stagflationary, and the demand for the reduction of rates and reform of GST is quite old.
The finance ministry has argued that these rate cuts are not linked to the penal tariffs on Indian exports levied by US President Donald Trump. It is argued that the government has been thinking of these cuts and that preparations for their implementation have been going on.
This does not answer the question ‘why now and why not incrementally over time’ as the realisation of the need to cut rates dawned on policy makers. For instance, talk of reduction of rates applicable to insurance has been going on for over a year. And what could have been more reasonable than reducing/eliminating rates on educational material, food items and medicines, as announced now?
The PM’s announcement of GST rate cuts came on August 15 in his Independence Day speech. This was soon after Trump signed an executive order on August 7, announcing the imposition of additional 25% penal tariffs on India from August 27.
Also, the cancellation of the visit of the US team of negotiators in August meant that talks had stalled. It became clear that tariffs on India would be higher than those imposed on India’s competitors so that they would displace Indian exports to the US. About $50 billion (about Rs 4.4 lakh crore, and 1.26% of GDP) of India’s exports would be adversely impacted.
Impact on demand in India
This would have a significant impact on demand in the economy, employment and growth. Due to the adversity and uncertainty it would hit investment, stock markets and the rupee-dollar parity. Not only would direct exporters be hit, but suppliers of inputs, raw materials and services would also be affected.
Since many of the items exported to the US are labour-intensive, unemployment would rise and that would further decrease demand in the economy.
The antidote to this hit is a demand boost in the economy. The obvious candidate is to boost internal demand. India with its 145 crore people, mostly rather poor and consuming little, can generate demand if their real incomes increase. And a cut in indirect taxes by lowering prices (provided the benefit is passed on to consumers) would boost demand.
The question is, would that be enough to counter the reduction due to the fall in exports?
Trump’s penal tariffs will impact demand in several ways. First, directly as exports to the US decline. Second, exports to other countries are also likely to decline since all countries will have surpluses and they would try to push them on to other countries. Third, knowing that Indian exporters will be hit hard, other countries will try to extract more discounts and concessions from them. Fourth, the world economy is likely to slow down due to higher tariffs and a fall in demand would start in the US and then spread to other countries. Fifth, workers’ wages are likely to be depressed everywhere, leading to a decline in demand. Finally, due to uncertainty, investments are likely to fall.
These factors could tip the world economy into stagflation or even a recession, leading to world demand falling steeply and impacting India’s exports much more than the loss in the US.
If the US was to reverse its levy of high tariffs all around and not just on India, the impact could be limited. But this seems unlikely. A US appeals court ruled against the levy of tariffs by Trump using emergency powers. The US government has appealed against this ruling in the Supreme Court. In the appeal, Indian trade with Russia is cited as a national security concern that required the use of emergency powers.
So, the tariffs on India are unlikely to be reduced at least till the US Supreme Court decides on the case.
In brief, the loss of export markets is likely to be a multiple of Rs 4.4 lakh crore, directly attributable to increased US tariffs.
India boosting demand
Exporters will not benefit from the cut in GST rates since exports are zero-rated – that is they do not pay GST. So, exporters’ demand will not change.
The expectation is that demand in the rest of the economy will rise and compensate for the fall in export demand. Will that happen?
While GST rates on some items will rise, for most items the rates will fall. On the basis of the detailed data for 2023-24 (unfortunately, not released publicly) available to the finance ministry, the revenue secretary stated that the net loss of revenue would be about Rs 48,000 crore. There was needless sensitivity about calling it a loss.
How much will this boost demand?
The rate increases for luxury, higher-priced items like cars, apparel and business-class seats in airplanes will cause their prices to rise. Demand for these items from the upper-middle class being elastic would drop.
The prices of items of common consumption where the rates have been cut will decline and that would spur demand for these items or lead to savings with consumers, which may be spent on other items of consumption or could be used to retire loans. Some increase in demand would follow.
The finance ministry says it cannot presently estimate this increase. In the last eight years of GST’s functioning, cuts in rates for a few items have been implemented but that has not boosted the share of consumption in GDP. Of course, this was masked by other factors like the pandemic.
But it seems unlikely that a net reduction of GST revenue of Rs 48,000 crore would spur an increase in demand to the tune of at least Rs 4.4 lakh crore. The arguments in the previous section suggest that the decline in demand will be a multiple of this amount. So, the announced cuts in GST rates are unlikely to compensate for the demand loss due to exports.
More importantly, GST is applicable to the organised sector and not the unorganised sector. So the cut in rates will lower organised sector prices but not unorganised sector prices. Thus, demand will be boosted in the former and not the latter. The disadvantage suffered by the unorganised sector (consisting of the micro and much of the small sector) due to GST will escalate.
Due to this relative price change, demand will shift from the labour-intensive unorganised to the capital-intensive organised sector. This demand shift will overwhelm any increase in employment and demand in the organised sector resulting from the rate cuts. The K-shaped growth of the economy will strengthen. This will react back to slow down organised sector growth as overall demand declines.
It is expected that capacity utilisation in the organised sector may increase due to a rise in demand and lead to greater investment in this sector. But that is unlikely since uncertainty has increased and the decline in the unorganised sector would slow down the economy.
Conclusion
In brief, the adverse impact on the unorganised sector is likely to overwhelm the positive impact of GST rate cuts on the organised sector.
All this is a result of the structural problems of GST due to the very large unorganised sector of the Indian economy. This was not taken into account while introducing the GST. Now that GST is a reality, it needs urgent reform to correct for this structural problem. Rate cuts and a few legal changes as announced now are not the required reform.
In brief, it is a good idea to boost internal demand which can be generated by 145 crore Indians and not depend so much on export markets. But the government’s steps are not designed to achieve that, since they will help the small (in terms of employment) organised sector at the expense of the unorganised sector, and that will only aggravate the demand problem.
Arun Kumar a retired professor of economics at JNU, is the author of a book on GST titled Ground Scorching Tax (2019)
The article was first published in The WIRE as The GST Rate Cuts Will Not Achieve Their Goal on 7th September.
Disclaimer: All views expressed in the article belong solely to the author and not necessarily to the organisation.
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Acknowledgment: This article was posted by Aashvee Prisha, a Visiting Researcher at IMPRI.
