The implementation of the Goods and Services Tax (GST), considered to be the most important policy change in India since economic liberalisation, has the potential to bring about large-scale economic impact. The initial commentary on the GST has revolved around benefits in terms of uniformity of tax structure, removal of cascading effect, efficient tax administration and improvement in government finances. On the flip side, the short-term impact of the transition is seen as a cause of lower growth in the economy. However, as we navigate through the current period of disruption, I believe that the narrative will change to productivity gains, formal jobs and better competitiveness. There is a need to delve a bit deeper to understand the forces at play.
With the benefit of hindsight, we now know that the impact of demonetisation went beyond unaccounted money; the real gain came from digitisation and formalisation of the economy, accompanied by an unprecedented move from physical to financial assets . The recapitalisation of public sector banks has been partly enabled by this tide of massive liquidity available with the banking system. Similarly, beyond efficiency transformation in taxation, the impact of the GST-led initial disruption has been underestimated because millions of enterprises are expected to make a shift in their approach towards cash, compliance and customer interaction. The GST is likely to have a positive impact by way of increase in competitiveness and productivity through improvement in quality of jobs, access to formal credit and significant reduction in the overall tax burden.
The effects of the GST on compliance and resulting teething issues for small businesses are well-documented globally. Notwithstanding the pain associated with this adjustment and compliance challenges, these changes are at best a short-term phenomenon. The effect on jobs on the other hand has not been considered significant internationally. However, the key difference in India is that 85% of the enterprises are in the unorganised sector, which is much more than any of the industrialised countries which have implemented some form of the GST.
First, the informal sector is almost 40% of the Indian economy and employs almost 75% of the labour force. However, a significant part of SMEs (in the informal economy) do not have economies of scale or a technological edge. They survive on the cash economy to evade taxes, provident fund liabilities and minimum wages to employees. This directly impacts competitiveness of other SMEs who do business by the rules. Too often, informal enterprises have taken advantage of an archaic tax system, impractical labour regulations and an ineffective oversight at the local administration level. The GST, therefore, shall result in a shift in business from the informal to formal sector. Quality of jobs in formal enterprises will improve, giving a fillip to the government’s Skill India initiative. Going ahead there will be an increase in demand for better skills as firms try to build sustainable enterprises.
Second, with formalisation and digitisation, financial institutions would be able to cater to the credit needs of SMEs who were hitherto outside the purview of the financial system, by providing greater access to working capital. A lot of the traditionally strong sectors of the economy such as footwear, leather, textiles, plastics, chemicals and food processing shall be the early beneficiaries of this trend.
Third, the measures of the government to ease the compliance burden on SMEs (single-return filing in a quarter, higher limits under the compensation scheme, significantly reduced penalties on delayed tax filing, etc) are likely to give a fillip to better-run enterprises by reducing compliance cost. Reduction in the rate of corporate tax and a one-time waiver for bringing past records of labour and production can be an additional boost. A small intervention earlier this year, allowing firms to come clean on their actual staff strength without getting penalised led to a 26% rise in the EPFO subscriber base from 38 million in December 2016 to 48.1 million by June this year. We might be underestimating formal jobs by a huge margin anyway.
Fourth, relocation of productive resources, including capital, within the SMEs shall lead to immense improvement in productivity. Jobs in such enterprises would be unlike ‘subsistence’ jobs in the informal sector, with no social security benefits. In addition to direct job opportunities for the entire fraternity of tax consultants, accountants and compliance officers, the GST could lead to 11-18% growth in formal jobs in sectors including cement, logistics and e-commerce. The evolution of e-commerce has already expanded the scope of the market for these SMEs who now have a global market to cater to.
By all counts, the GST and the demonetisation-led formalisation of the economy is as big a transformation as the 1991 economic reforms. The opening up of the economy after the abolishment of the ‘licence raj’ was seen by sceptics as a death knell for indigenous enterprises and manufacturing, resulting in mass unemployment. Contrary to this, most domestic firms became more productive and efficient in the wake of foreign competition. India now has a reasonably large formal sector, which is globally competitive. Overall, the reforms proved to be a watershed moment in the evolution of the Indian economy. Juxtaposing 2017 to 1991, this phase of economic reforms is integrating India’s internal market and making it easier for firms — both domestic and foreign — to compete on the basis of efficiencies in production and service. Demonetisation brought an incremental 9.1 million people under the tax net. The GST is expected to do the same for enterprises, bringing at least a million new enterprises under its ambit.
Over the medium term, export competitiveness shall also improve as a result of seamless taxation, reduced compliance cost and savings in logistics for formal businesses. The long-term tax burden itself is expected to reduce by 25-30% as per the Reserve Bank of India’s working paper on the impact of GST. The shift of productive resources, credit and government facilitation, from inefficient to efficient producers will go a long way in making the industry globally competitive. The fear of job losses in the informal economy would be more than compensated by a wider spread of employment opportunities coupled with better quality jobs in the formal sector.
We are in the middle of a sea change in the economic landscape of India. Digitisation and GST-led formalisation of the economy is leading us towards a more efficient and sustainable economy.
Rana Kapoor is MD and CEO, YES Bank