GST in the year of demonetisation will be an overkill but it can't wait long

Dated 5th December, 2016

Could one game-changer move end up seriously impairing another game-changer? Will the Narendra Modi government’s bold demonetisation move affect the way the goods and services tax (GST) regime plays out?

Outside of the last meeting of the GST Council on December 1 and 2, state finance ministers were reported to have discussed the effect of demonetisation on their finances with finance minister Arun Jaitley. (The issue could not be discussed at the Council meeting itself because the issue does not fall into its jurisdiction.)

The states could well be raising the issue for purely political reasons or to bargain for higher compensation (which can be addressed if the Centre so wishes), but there are concerns about the economic impact of GST implementation so soon after demonetisation.

“GST is best brought in when the economy is thriving; you don’t create a compression and then implement it,” says R Kavita Rao of the National Institute of Public Finance and Policy (NIPFP), who has been closely involved in the whole process of framing the GST regime.

There are various estimates about the extent of the impact of demonetisation on demand and growth, as also about how long these effects will last, but there is general consensus that there will be an immediate adverse effect. Rao points out that small businesses especially will be most affected by the move and they are also the ones who will have to make more adjustments for the GST regime.

“By itself GST would be a disruptive development; now the disruption will be larger. Smooth adjustment will not be possible,” Rao argues. Large firms will also be affected by a drop in demand but they are, she says, more or less GST-ready; the small firms are not.

But can the government wait for the economy to settle down before moving into the final stage of GST? That seems unlikely. For one, the Modi government’s prestige is at stake – this is one of the big bang reforms it can claim credit for. Besides, the initial one or two years of GST will be a bit painful but things will look up after and Modi may want the high to come closer to the 2019 election. More importantly, there is also a constitutional timer ticking – Jaitley has pointed out that GST cannot be delayed beyond September 2017. The constitutional amendment ushering in GST says the prevailing indirect tax regime can continue for just a year after the Act was notified. Since it was notified in September, the current tax regime will have to end in September 2017.

Rao agrees this does complicate matters, but suggests a way out could be found. “If you do it now, GST will be a killer,” she warns.

Even without demonetisation, implementing GST from April 1 would have been a bit of a stretch, she believes. The supporting legislations have not been passed and businesses will need to understand the implications and prepare for the new regime. As things stand, even the GST Council has not cleared the draft of these legislations.

The last meeting of the Council got deadlocked over the sharing of administrative powers. In September, there was consensus at a Council meeting on states having jurisdiction over transactions below Rs 1.5 crore, the centre and the states having dual control over transactions above that threshold and the centre having exclusive jurisdiction over service tax. This writer had pointed out then that working out the mechanics of this may not be easy.

Some states have raised objections to the exclusive jurisdiction of the Centre over service tax. Rao feels this is a point that needs to be addressed. For states, especially small ones, some services may yield large revenues. For the Centre, however, collections from these may not amount to very much and these may slip under the GST radar.

Another problematic issue is that of dual control in the case of the integrated GST (IGST, which is levied on inter-state movement of goods). All these concerns are genuine ones for which solutions need to be found, Rao says. “The aim should be to ensure that, as far as possible, the tax payer has to deal with only one administration.”

Jaitley has said he has his fingers crossed about progress being made in the next meeting of the GST Council on December 11 and 12. Everyone will be on edge till then.