The unintended consequences of GST

A lot of dust has been kicked up over the economy in the recent past. It started with former Finance Minister and BJP veteran Yashwant Sinha’s savage attack on his party colleague Arun Jaitley’s handling of the portfolio that he once managed. Then Prime Minister Narendra Modi used a banal forum like a meeting of the Institute of Company Secretaries to make his most comprehensive speech on the economy till date.

Tweaks to GST

Despite the counter-attack, the criticism clearly hit home, since the government followed it up with some ‘big bang’ changes to the Goods and Services Tax regime aimed at addressing the immediate pain points of small and medium businesses, exporters, and the like. Tax rates have been reduced on several items, small and medium businesses with an annual turnover of Rs. 1.5 crore have been exempted from tedious filing of monthly returns and have been given a quarterly option, and businesses with a turnover of up to Rs. 1 crore have even been given the option of paying a flat 1-5% tax and effectively disengaging from the rest of the GST system. The GST on exports has also been cut to 0.1% till 2018 to help exporters tide over their current liquidity challenges.

I am not, however, going to talk about these changes. As far as the tweaking of the rates itself is concerned, it is a good thing, in as much as it shows that the tax mechanism itself is capable of being flexible and responding quickly to changing circumstances. As far as giving exemptions from filing returns — the so-called ‘composition scheme’ for a flat tax — are concerned, these are, in principle, a rollback of the reforms ushered in by the switchover to the GST regime. Because once you start exempting bits and pieces of the economy, the seamless tax chain across the entire value addition chain envisioned by the GST actually falls through.

Intended and unintended results

Which brings me to the key issue — dealing with the consequences of change. Every reform naturally has consequences. Many of them are intended. In the case of the GST, the intended consequences were to create a simpler and unified indirect tax system across the country, remove incidences of multiple taxation, and ensure that the entire economy engaged in value creation also becomes a part of the tax system.

But it is the unintended consequences of change which are harder to deal with. Unfortunately, it is very difficult to predict before formulating a policy what these unintended consequences could be. It should, however, be possible to identify these unforeseen side effects post facto. More importantly, there also has to be a policy response to deal with such developments. Otherwise, the danger is of pain leading to more pain without any gain.

What are these unintended consequences of the GST? The biggest, of course, is the havoc it has wreaked on the entire informal sector of the economy, which actually accounts for the livelihood of a bulk of the population. This is also why we have such a low official unemployment rate because, while the organised sector workforce accounts for just a fraction of the jobs, the informal sector ensures that 95% of the population earns a living.

Informal sector hit

It is this mass of people in the informal sector who have been flattened by the GST. The other day, for instance, at the Khadi Gramodyog Bhavan around the corner from The Hindu ’s office in Chennai, I found a woman standing with a basket of handmade dolls for delivery (Navaratri is also the doll-buying season in the south), arguing with the store’s accountant. He was vainly attempting to explain to her that he could not make payment for any supplies without the vendor’s GST number, a concept this village artisan had never heard of. For this woman, Friday’s reduction of GST on handicrafts from 18% to 5% is meaningless. She has simply lost a substantial chunk of her working capital and months of labour. And even if she gets a GST number later, what would be the compliance cost for such a person, and what kind of tax credits can she actually avail?

Take the apparel sector. Almost the entire sector — over 2 million units — consists of tiny units, officially ‘employing’ an average of just 1.5 persons each, usually the owner and another family member. The rest are jobbers and temporary hands who will now have to become registered vendors with GST numbers if these tiny units are to get the benefit of GST. Anecdotal evidence suggests that a huge number of these units may either simply fold up or be forced to lay off their jobbers and tempers — or else officially absorb them as workers, which will definitely make them non-competitive.

Do we have a plan to deal with such massive lay-offs? Do we have an alternative plan to fill in the gap left by the 15% share of exports currently contributed by the textiles sector, for instance?

Sometimes, unintended consequences can end up being far more impactful than the intended ones.