On 31 August this year, the CSO released GDP data pertaining to the April-June quarter of the current fiscal which showed GDP growth falling to 5.7 per cent ~ its lowest in three years. The liberal economists joined the political opposition in painting a bleak picture of imminent collapse of the Indian economy, blaming the fall in growth entirely to the disruptions caused by demonetisation and GST. But the decline of growth only confirmed the continuing downward trend since the last quarter of 2015-16, long before Rs 1000 and Rs 500 currency notes were demonetized.
GST was introduced only in July 2017, and its impact would be more visible in the second quarter’s results, which I guess won’t bring much cheer. Behind the declining growth were such factors as a steady deterioration in the export sector, stagnant credit growth and an under-performing banking sector, combined with weakened domestic demand caused by demonetization. The introduction of GST was indeed a bold step fraught with a high political risk. So radical an economic reform can make and unmake governments.
The most striking example is that of Canada, whose GST has many features in common with the Indian GST. In January 1991, the country’s Prime Minister, Brian Mulroney, introduced a dual GST like India’s, replacing a highly unpopular 13.5 per cent Manufacturers’ Sales Tax which was hurting its international trade and export competitiveness. The Government thought that a harmonised GST was the remedy.
Its Introduction in Canada was rather messy; inflation soared and growth declined immediately and GST could not raise the tax levels sufficiently in order to contain the rising fiscal deficits. The economic slump led to widespread public resentment, and GST became the object of public wrath. Mr Mulroney and his Progressive Conservative Party (PCP) had to pay a steep price for this. In the parliamentary elections of 1993, PCP’s strength in the 295-seat House of Commons was reduced from 169 to only two seats! PCP could never recover from the shock. It eventually disbanded itself and merged with the Canadian Alliance to form the Conservative Party of Canada in 2004.
The opposition Liberal Party under Jean Chrétien won the 1993 elections on the promise to repeal the GST but instead of repealing, it strengthened and streamlined this tax regime. Chrétien later apologised to the electorate for reneging on his election promise. Canada now administers a federal GST together with either a provincial sales tax (PST) or a harmonized sales tax (HST) levied by its provinces. While the federal GST rate has come down from 7 per cent in 1993 to 5 per cent now, the HST attracts a uniform rate of 15 per cent, while the PST rates vary between 6 and 10 per cent. GST is a disruptive reform and needs to be managed carefully.
Managing disruption is never smooth or easy. There are bound to be hiccups which can be very unsettling, both economically and politically. To be sure, GST is not a miracle cure for everything that ails the economy. Prices take time to adjust in a market economy, and the effect of the GST can be seen only over time and not overnight.
As in India, GST in all countries has followed introduction of VAT. France was the first to introduce VAT way back in 1954. As many as 160 countries today, including all OECD countries except the US, have some form of VAT or GST.
Many countries have introduced GST by harmonising the taxes on goods as well as on services, partially if not wholly, but very few of them have a federal structure, and hence the attendant complexities like ours. Some of the countries which have harmonised the taxes on sales of most goods and services include France and Italy, UK, South Korea, Japan, Singapore, Sweden, Hong Kong, China, Austria, Malaysia, Canada, Germany, Russia and Australia, the last six being federations. In Australia, GST was introduced with effect from 1 July 2000. Although the idea had existed since 1975, it was always treated with considerable scepticism. The proposal was revived in the 1990s by the Liberal Party leader, John Hewson.
But after being asked by journalist Mike Willessee to explain the arithmetic of how the price of a birthday cake would be affected by the proposed GST, it was given up on the assumption of being “too complicated”. In that interview, to Willesee’s question, “You tell us in what you’ve published that the cost of cake goes down, the cost of confectionery goes up, there’s icing and maybe icecream, and then there are candles on top of it”, Hewson could only say, “ To give you an accurate answer, I need to know exactly what type of cake to give a detailed answer”.
This prompted Willesee to retort, “If the answer to a birthday cake is so complex, you do have an overall problem with the GST, don’t you?” In 1996, the Liberals won the federal elections after promising ‘never ever’ to introduce GST.
The ‘never ever’ lasted for only two years, when, under the leadership of John Howard, Liberals fought the 1998 election on the issue of introduction of GST that would replace all existing sales taxes and apply to all goods and services.
Despite a negative vote swing of 4.61 per cent, they formed the next Government and introduced GST in 1999, replacing the federal wholesale sales tax system. Gradually many State and Territorial Government taxes, duties and levies such as banking taxes and stamp duties were abolished. The consequent budget shortfall was compensated by the revenue earned from GST that was shared with the States. Simultaneously, for greater acceptance, rates of federally levied personal income-tax and company tax were reduced to absorb the shocks emanating from GST.
It was understood that this tax would take time to stabilise, and its intended consequences like reduced business costs, which would spur consumer demands, would flow over time, and no miracles could be expected in the short term. In the 2001 federal elections, the opposition Labour party made its rollback a centre-piece of its electoral campaign, describing it as a “bastard tax”, but lost the election.
Australian GST has a rate of 10 per cent with a system of input credits, as in India. Like in Canada or France, here also concerns were raised that GST would impact the poor much more than the rich, being a regressive tax, but the likely regressive potential was mitigated by adopting a set of measures like abolition of federal wholesale sales tax as well as some stamp duties and fuel taxes, besides effecting reductions in rates of personal income tax and state banking tax side by side with the launching of GST. But the reactions and counter-reactions were very much like what we are witnessing in India today.
The behaviour of business and consumers was also strikingly similar in the two countries. In the period leading to the introduction of GST, consumption rose sharply as consumers had rushed to buy goods that they perceived would be more expensive in the post-GST period, and traders and businesses de-stocked and cleaned up their inventory by offering lucrative discounts, just like in India. Thus immediately after GST came into effect in July 2000, both consumption and economic growth declined. Inflation soared by as much as 2.8 per cent in the quarter ending September 2000. In the first fiscal quarter of 2001, the Australian economy recorded negative economic growth for the first time in more than 10 years.
The opposition, exactly as in India, cried foul and blamed GST. As in India once more, small businesses complained of cumbersome procedures and glitches faced in online submission of quarterly Business Activity Statements to the Australian Taxation Office as required under law. A particular study estimated that costs of compliance to the new tax system amounted to 3 per cent of the annual turnovers of small businesses.
But consumption soon returned to normal and growth picked up gradually. In each of the countries that had introduced GST, the economy had under-performed in the year of its introduction, something that was anticipated and in fact, is being witnessed in India today. One study mentioned the negative impact of GST on the real estate market, projecting a steep rise in prices of new homes by 8 per cent and a steeper fall in demand by 12 per cent.
But the real estate market boomed between 2002 and 2004 with prices and demand both soaring, especially in cities like Sydney and Melbourne. Ten years hence, GST was recognised as a resounding success in Australia that had replaced inefficient taxes that imposed high deadweight costs while raising little revenue. As Professor Sinclair Davidson of RMIT University wrote, “The GST was the last great tax reform that Australia experienced. In the subsequent ten years we have become accustomed to tax cuts, not new taxes.”
(To be concluded)
(The writer is a commentator. Opinions expressed are personal)