Is GST Good Politics, Good Economics, Or Both, Or Neither? Modi Must Keep His Fingers Crossed

Sometimes, good economics may make for bad politics. There is just a small chance that the goods and services tax (GST), India’s boldest and riskiest tax reform, may give the National Democratic Alliance (NDA) government a greater headache that it may have bargained for. We can’t go back to the drawing board on this one, but Prime Minister Narendra Modi will have to keep some political capital ready to invest in the project if things go wrong.

Speaking yesterday (23 April) at a NITI Aayog governing council meeting, Modi was quoted as saying that “the consensus on GST will go down in history as a great illustration of cooperative federalism. GST reflects the spirit of ‘one nation, one aspiration, one determination’.”

Maybe, but knowing the fractious nature of Indian politics, one has to keep one’s fingers crossed. Even assuming GST delivers on the revenue front after an initial lag, one has to realise that it goes counter to the long-term trend of devolving greater powers to states. It centralises in the GST Council the powers of indirect taxation, and could thus be a constant source of friction between centre and states, or between states if some gain or lose more than the others, especially if politics makes its presence felt. It is worth noting that two chief ministers – Mamata Banerjee and Arvind Kejriwal – failed to show up for the Prime Minister’s meeting at NITI Aayog, and Tamil Nadu has been a consistent dissenter on GST.

It is easy to keep repeating the truism that good economics makes for good politics, but one cannot be sure of this all the time. The GST may be good economics in the long run, if tax evasion falls and revenues boom, but in the short term it could also lead to bad economic outcomes – and possibly bad politics as well.

The problem with the GST is that it tries to unify the aspirations of the weaker states and the stronger ones through a tax regime whose outcomes may not be equitable. As Praveen Chakravarty and Vivek Dehejia wrote in Mint newspaper a few months ago, “robust inter-state mobility of goods and people points towards GST worsening economic divergence among states. For, if it is underlying deeper factors such as higher private sector productivity, and better quality of governance… that distinguish leading from lagging states, these are factors that will not disappear simply because goods and people are on the move. Rather, these could be self-reinforcing trends, driven by economies of scale, agglomeration effects and network externalities…”.

The common currency euro, which everyone lauded as the best thing since sliced bread, is now the cause of much angst in the European Union. It has forced weaker economies like Portugal, Italy, Ireland, Greece and Spain to adopt extreme austerity measures that have sent unemployment soaring all over southern Europe. The euro experiment is less the toast of the EU, and more the cause of acrimony, with several anti-EU parties now considering a referendum on exiting the union a la Brexit.

Make no mistake, the GST is as big an experiment for India as the euro was for the EU. The risks are as great.

It may be too late to subject the GST to extreme scrutiny since we no longer have the option to pull back from the brink, but there is no harm discussing whether it is good politics and good economics.

Here are the questions on economics and politics.

How is one-nation-one-tax good for 29 states and several Union territories and the centre when they have diverse economic capabilities, strengths and weaknesses?

How is it good economics, if, in the initial years, the government has to provide full compensation for revenue losses and 14 per cent growth every year to every state, never mind whether you have a drought year, an industrial recession, or deteriorating bank balance-sheets? Will the blank cheque to states not make the fiscal deficit worse if revenues don’t show up in the first two years?

How is it good economics if the initial impact of new GST rates is mildly inflationary, and worse, imposes even higher burdens on services, where there are fewer setoffs for taxes earlier paid in the supply chain? If 60 per cent of GDP is services, is it good economics to burden this dynamic sector with higher taxes?

How is it good economics when a disruptive change in the tax regime comes exactly at the wrong time when industry is down, banks are struggling to remain profitable, and small businesses are struggling to grow?

How is it good economics when businesses have to focus on rejigging their supply chains when they are simultaneously trying to deleverage and start reinvesting? Now, the higher profits (if any) will have to go to complying with GST, and rethinking their supply chains to optimise on taxation.

How is it good economics to put all eggs in the GST basket, and that too in one go, while abandoning the old baskets of excise, VAT and service tax? Would it not have been better to introduce a 1 per cent GST without ending the old excise-VAT regime fully, so that we can see what happens to revenues under GST before phasing out the old and ring in the new?

Now, we can ask whether this is even good politics.

How is it good politics when we reduce each state’s freedom and flexibility in raising revenues by lumping everyone – centre, states, and union territories – into one common bucket where consensus is the only way out. And if things go wrong for a state, should we expect more acrimony or less?

Will Narendra Modi not get all the political blame if things don’t work out in the initial years of GST? In the long run, everyone is bound to lose an election. And regional parties, already fretting about how powerful the BJP is getting, will not be willing to play ball if economic outcomes in states diverge to a large degree.

(Note: A part of this article was published earlier in DB Post)