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Context

In theory, the shift to GST made eminent sense, yet in practice, some of these expectations have been belied.

Why have GST collections not measured up to expectations?

• This could be due to a combination of three factors:
• First:  The tax rates under GST are lower than in the earlier regime-GST was not revenue neutral, to begin with.
• Second: There has been massive tax evasion due to under-reporting, input credit scams and fake invoices
• Third: A slowing economy has impacted firm revenues, and thus tax collections.

GST should have been revenue-neutral but it is not

• Fitment exercises not carried out: The fitment exercise should have been undertaken in a manner so as to ensure that collections pre and post GST are the same.
  • But, this fundamental principle was not adhered to, and other considerations dominated.
  • Revenue neutrality Vs. Multiple objectives: The GST council began its deliberations not with the single objective of revenue neutrality, but with multiple objectives in mind.
  • Closeness to existing tax: Council wanted to ensure that rates were close to the existing tax incidence (accounting for cascading); to ensure minimal impact on inflation.
  • Not regressive: The council also wanted the proposed rate structure was not regressive in nature.
  • The council wanted that items of mass consumption were not taxed at a higher rate.
  • Achieving all these objectives simultaneously proved a difficult task.

The issue of tax evasion

• It is difficult to arrive at firm estimates of the scale of the problem but there are some indications of its size.
• In West Bengal, it was estimated that the value of goods (July 2017 to March 2018) entering a state appeared to be under-reported by around Rs 50,000 crore.
• Rs 60,000 crore in Madhya Pradesh, and Rs 1,50,000 crore in Maharashtra.
• Numerous cases of tax fraud and fake invoice scams have also been detected since then

Problems involve and possible solutions

• Invoice matching:  It is argued that invoice matching will help if implemented it from the beginning.
  • It could have helped plug the loopholes.
• Issue of under-reporting: It is debatable whether invoice matching can end under-reporting (collusion) and fake invoices.
• Limit of state capacity in handling cases: The Central and state administrations can intervene in only about 3 lakh cases in a year.
  • Their capacity to track lakhs of transactions on a daily basis is questionable.
• Slowing economy: Already existing structural issues have been compounded by the slowing economy.

Way forward

• There are certain options available to the government.
• First: Either recalibrate the expectation or carry on the efforts to plug the loopholes and the shortcoming in the system.
• Second: Lower the cut-off for composition scheme. A higher level simply encourages business “splitting”.
• Third: Reduce exemptions.
• Fourth: The council must deliberate on the rate structure, bringing it in line with pre-GST levels.

Context

High inflation has reduced the fiscal space available for a rate cut.

RBI target of 6% breached.

• CPI at 7.35 %: Retail inflation, as measured by the consumer price index (CPI), has surged to 7.35 per cent in December 2019.
• Latest inflation data seems to corroborate fears articulated by the Monetary Policy Committee (MPC) in its December meeting.
• In the meeting, MPC refrained from cutting the benchmark repo rate.

Consequences for the economy

• Reduced scope for fiscal slippage: High inflation reduced the space for further easing of policy rates.
  • Even after clarity over the extent of the Centre’s fiscal slippage emerged.
• Rise in yield for 10-year securities: The 10-year G-sec yields have reacted sharply to these developments, rising to 6.67 on Tuesday.
  • Offsetting operation twist: Rise in yield resulted in offsetting the impact of the RBI’s recent open market operations.
• Inflation targeting under stress: The combination of weak economic activity and higher than expected supply-side inflationary pressures has put the inflation-targeting regime under test.

Reasons for the inflation rise and chances of easing

• Food prices rise: Much of the rise in the headline inflation number can be traced to higher food prices.
  • Food inflation has risen to a near six-year high of 14.12 per cent in December 2019, up from 10.01 per cent in the previous month.
  • Vegetable prices have surged to 60.5 per cent in December, contributing nearly 3.7 percentage points to the headline numbers.
• Chances of ease in coming months: While vegetable crop cycles tend to be short, and supply-side pressures may ease in the coming months.
  • The stickiness in prices of protein items is likely to provide a floor for food inflation.

Bleak outlook for inflation easing

• No short-term return to normal level: Food inflation is unlikely to revert to previous levels in the short term.
• Household inflation expectations, a key metric in the MPC’s assessment, are more responsive to food inflation, this will further exert upward pressure on MPC.
• A factor of hostilities in the Middle East: The uncertainty over oil prices on account of hostilities in the Middle East, adds to the bleak outlook for inflation.

Conclusion

With limited fiscal space for a meaningful stimulus, the government intends to support the economy during this rough patch, and return growth to a higher trajectory.