The combined effect of demonetisation and GST would slow growth in the short run. But by FY 2019, it will give the government a fiscal flexibility that no other Indian government would have seen.
The Indian economy is heading towards a unique trajectory — bitter over the next two-quarters till end-2017, sweet beyond that — that will capture the following.
One, the growth of gross domestic product (GDP) will decrease in the short term and makeup in the medium to long term.
Two, the growth of tax collections, both direct and indirect, will increase in the short term and consolidate itself to a new normal in the medium and long term.
Three, as a result of the above, the tax-GDP ratio will jump in the short term and show a consistent but slower rise beyond that.
Four, by FY 2019 — around the time India will go for general elections — the government will be acting from a position of a full treasury.
Five, that growing treasury will give the government a fiscal flexibility that no other government would have seen.
These are consequences of two disruptive policy actions — demonetisation and the introduction of the goods and services tax (GST) — both of which lead the economy in the same direction.
Because it works only in the aggregate and not through anecdotes though the latter add up to and comprise the former, any macro economic policy disruption of any significance needs to be seen as an arrow of execution being unleashed from a bow of objectives. The arrow or policy sits on a string that is pulled back, aimed and loosed towards a target for its manifestation. The bow in a modern economy is to target, through the use of sophisticated tools — logic, global benchmarking and experiences, cost-benefits, and politics — and deliver large-scale economic goals, individually or severally.
In this process, from objectives to execution, governments are ready to accept short-term losses for a bigger and grander long-term objective. Both demonetisation and the GST are part of this bow and arrow narrative.
Enough has been written about the adverse impact of demonetisation introduced on 8 November 2016. The scintillating short-term evidence of which was the 130 basis point fall in India’s GDP growth to 6.1 per cent for the January to March 2017 quarter (the first full quarter after demonetisation and enough to assess its impact economically) from 7.4 per cent in the previous October to December 2016 quarter, and 7.6 per cent in the same quarter of the previous year.
Although a quarter is no indicator of rankings, within the confines of statistics, the quarter also saw India relinquish its position of being the world’s fastest-growing large economy to China, which grew by 6.9 per cent in the same period.
That the government is serious about the demonetisation policy as well as its outcome is beyond doubt.
Six months later, while aggregate numbers are still not out, and the old Rs 500 and Rs 1,000 notes returned to the banking sector still being counted by the Reserve Bank of India (RBI) — creating more negative speculation than mere numbers — there are several anecdotal cases are being reported, followed, prosecuted and arrested, and the modus operandi of tax evaders being analysed.
According to an analysis by the Income Tax Department, of the 1.8 million persons identified for verification, taxpayers provided 1.3 million accounts involving cash deposits of Rs 2.89 lakh crore. Search actions were conducted on 900 groups in which undisclosed income of Rs 16,398 crore was admitted, while survey actions were conducted in 8,239 cases in which undisclosed income of Rs 6,746 crore was detected.
More than 400 cases were referred to the Enforcement Directorate (ED) that arrested 18 evaders and the Central Bureau of Investigation (CBI), which arrested 38 evaders.
Further, since demonetisation, we have seen the number of taxpayers rise by 9.1 million, according to Finance Minister Arun Jaitley.
This is a great start, the trend of which we expect to continue over the next few quarters.
The policy of converting demonetisation into a tool for increasing taxpayers is working, and the moral messaging embedded in the policy — cash is risk — is getting through to evaders. “One message has gone out clearly as per the steps taken by CBDT post demonetisation,” Jaitley said. “It is no longer safe to deal with excessive cash and tax evaded money. It is absolutely clear that those who have been indulging in all these are no longer safe.”
There is a method working behind this: technology and big data, using which evaders have been identified.
In the second phase of the government’s Operation Clean Money, more than 60,000 persons, including 1,300 high risk persons, have been identified for investigation into claims of excessive cash sales during the demonetisation period, while more than 6,000 transactions of high value property purchase and 6,600 cases of outward remittances shall be subjected to detailed investigations, Central Board of Direct Taxes chairman Sushil Chandra said: “If you are doing something wrong, there is not only one department, other departments will also take action simultaneously.
Fear should be in the mind of the assessee if they are doing something wrong. There should be no fear in the mind of honest taxpayer.”
If technology and data analytics has delivered results, both financial and moral, around demonetisation and direct taxes, the GST goes one step ahead on the GST and indirect taxes front.
Here, the linkages of databases, big and small, through technology that is wired into the Goods and Services Tax Network (GSTN) is embedded into the very conceptualisation, construction and execution of the policy.
The entire system is electronic. Incentives have been created to ensure compliance — one entity cannot get tax credits if the previous entity does not pass it.
Although the hard and almost unrelenting compliance could be harsh on the technologically-challenged, the Indian entrepreneur is smart enough to learn.
Other issues like electricity or broadband availability are being addressed through GST Suvidha Providers. It is a clean system, the benefits of which will show up in the last quarter of FY 2018.
Those who said the GST system would collapse under the weight of transactions as it comes to life on 1 July have been proved wrong beyond doubt. The GST takes India to a more efficient, cleaner and less stressful tax system. But as has been expressed here earlier, the next two-quarters, from July to December 2017, the transition to GST will extract a price.
And that price will be in the form of a slower GDP growth. This will be the policy bow being pulled.
The arrow unleashed, the stability of the GST system will come in the January to March 2018 quarter, after which the uptick will be sharp.
This will be due to a rise in the number of taxpayers as well as the amount of taxes that were so far being evaded — on indirect taxes of course, but on direct taxes as well.
The next three-quarters, from April to December 2018, will see the treasuries of both the Central and State governments fill up. On the Central side, this will give Prime Minister Narendra Modi the leeway to do three things.
One, invest the surplus in further accelerating economic growth by spending on infrastructure — good economics, good politics.
Two, use the extra indirect taxes collected to reduce individual income taxes — good politics, good economics.
And three, fritter it away on entitlements like introducing the universal basic income — good politics, bad economics.
This would come at a time when India would have shifted from a fiscal year that begins on 1 April to a calendar year that harmonises finances with the rest of the world.
Meaning: the last Union Budget of the Modi government will have the executive mandate to spend this extra money without conflicting with Election Commission rules.
Those who are already paying their taxes, direct and indirect, have nothing to fear — nothing changes for them. Those who are not must pay the penalty for the rest of us subsidising their diamonds, SUVs and real estate. Those who live and die by stock tickers may want to build these uncertainties into their models and expectations. And finally, those of us who study and engage with the economy needs to come to terms with a slower growth — but growth, no doubt — in the short term that will be a precursor to an even more dynamic India beyond as the policy arrow hits the target.
This article was first published on Observer Research Foundation and has been republished here with permission.