A poorly implemented version of the GST could negatively affect the Indian economy for years to come.
As 1 July approaches, India is girding itself for its second historical financial reform in the of twelve months — the advent of the Goods and Services Tax (GST). Unlike the unexpected demonetisation reform that took place in late 2016, the implementation of the GST has long been in the works with initial discussions starting almost a decade ago. In formulating and implementing the GST, which is meant to streamline the indirect tax system of India by amalgamating its many central and state taxes, the government has set ambitious goals. The benefits of the reform are undeniable — it will help bring India's informal sector into the fold, lower business costs across most sectors, increase exports and reduce incidences of unnecessary double taxation. However, there remain certain concerning issues related to the implementation of the new tax system. The problematic input tax credit issues, the uncertainty related to the functionality of the GST information technology system, and the ambiguity of the anti-profiteering clause could all end up sinking an otherwise promising economic endeavour.
One potential issue in the implementation of the GST centres on the documentation requirements for input tax credits and the stage at which the credit accrues. The new system will require suppliers to provide a bevy of documents in order for the tax credit to be released to the customer, which can lead to significant short-term cash flow issues for customers. Most businesses strive to have efficient working capital (i.e. the amount of cash kept on hand to bridge the period between receiving cash from their customers and paying cash to their suppliers). If an entity can keep less cash on hand for the day to day activities, it can invest more in other activities, which can be as ambitious as business expansion or as simple as an interest bearing savings account.
The new documentation requirements needed to receive tax credits throws a wrench in working capital calculations for Indian businesses. As the input tax credit can only be released once the supplier has submitted adequate documentation, businesses will have to account for potential delays and keep extra cash on hand, thereby reducing money available for potential growth and investment activities. It is possible that due to cash flow strains certain small businesses might even have to borrow money to fund their day to day activities, or in the worst case scenario, shutter their operations.
Another key implementation issue could stem from the proposed technology backbone of the GST system. One of the lynchpins of the GST is the integrated technology network (known as the GSTN) that will allow for seamless documentation, recording of debits, and dispersal of credits. An ambitious endeavour, the platform aims to hold up to 70 million user accounts. Yet, no one has been able to ascertain if it will be functional on 1 July, the rollout date for the GST.
Trust in the GSTN has already been brought up as an issue, with the lack of transparency into the majority privately owned organisation being cited as a major area of concern. If the delays in registering users causes a functionality issue or the GSTN is not able to properly support the rollout on 1 July, public trust issues could end up causing the failure of a breakthrough financial reform.
A third implementation issue that could sideline the GST is the proposed anti-profiteering clause. When indirect tax reforms have been implemented in other countries, businesses have kept prices the same and used the savings incurred from a change in tax systems to bolster their own profit margins. In order to stop undue profiteering from changes in tax systems, an anti-profiteering clause has been added to the GST. The clause requires that businesses pass any benefits from the change in tax systems to the end consumer. The clause does not, however, provide any mechanism for the monitoring of anti-profiteering activity. The clause and any subsequent investigation, will instead be triggered by "credible complaints" according to Revenue Secretary, Hasmukh Adhia.
The uncertainty associated with the anti-profiteering clause could have detrimental effects on both businesses and consumers. The private sector fears that ambiguity in the clause will lead to "witch-hunts" as tax authorities are given leeway to make subjective judgements as to whether a business is profiteering, without any regulations or laws to back their rulings. On the other hand, consumers fear that ambiguous regulations or laws will lead to a lack of transparency and that decisions regarding the applicability of the anti-profiteering clause will be made on an ad hoc basis depending on political connections or even worse, outright corruption. The lack of clarity can, once again, have a detrimental effect on public perception regarding the GST.
The issues surrounding the GSTN can be managed if more time is given for testing and auditing. Similarly, the problems with the anti-profiteering clause can be ironed out with more time and the implementation of widespread education and price monitoring policies in the lead up to the GST. The documentation requirements and their subsequent effects on cash flow and small businesses are more difficult to sort out. Perhaps more time needs to be spent by the powers that be, in the formulation of policies centred on the input tax credit and its documentation requirements.
The GST is an ambitious plan and the Modi government has set similarly ambitious benchmarks for its implementation. The wisest course of action, however, might be to delay the rollout of the GST for a few months in order to not repeat some of the mistakes that were made during the hastily carried out demonetisation reform. A poorly implemented version of the GST could negatively affect the Indian economy for years to come.
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Hosuk Lee-Makiyama Director European Centre for International Political Economy
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