A great adventure begins

At long last, after a wait of close to two decades from the first idea to the first implementation, the Goods and Services Tax is here. The impact on businesses--most businesses except the tiniest local ones--will be substantial. In recent weeks, there's a good amount of investment research and analysis on the impact of GST on companies. All of this is focussed on the impact of GST on the output of a business, as well as some rudimentary analysis of the first-order impact that input cost offsetting will have on costs.

I suppose at this stage, that's all that is possible. However, such analysis of the impact of GST is actually worse than useless because it is positively misleading. The reason is that the negative impact is quantifiable, while the positive impact is not quantifiable. You can say that so and so goods are now being taxed this much more at the point of sale than they were earlier. That looks like a negative. However, the scope for input tax offsetting is not well understood, even by the primary manufacturer or supplier, or for those supplying inputs except in the simplest of cases.

The ability to buy goods or services from any part of the country, and still be able to offset the tax portion, is the real game changer for businesses. While one can be certain that such an effect will be there, quantifying it at this stage is impossible even for businesses themselves. Add to that the side effects of the way input credit works for Central, State and Interstate GST, it's not possible to quantify exactly how competition will play out and what advantages businesses will derive from the new nationwide common market.

There's another interesting theme in the way people are reacting to GST, and that's this whole 'traders and small businesses in trouble' idea. Around the country, traders of various kinds are said to be on strike, or at least quite distressed by GST. Many of them claim--at least as quoted in the media--that they are on the brink of ruin, with the implication that we are probably heading for a substantial economic crisis.

However, I wouldn't take these claims at face value. Businesses that are too small to cope with taxation are below the GST limits. The rest are used to not paying tax and are now facing the prospect of a system that will be hard or impossible to cheat. I've personally watched over decades businesses run by friends and acquaintances that have simply never paid taxes. When demonetisation hit, I came across an example of a wholesale market in Delhi where most businesses had not even registered for tax.

This actually brings up the real problems that will have to be solved in the GST regime. This widespread, successful avoidance of indirect tax by small and medium sized businesses is obviously facilitated by deeply corrupt taxation systems. In many parts of the country, sales tax staff do not want (and actively prevent) businesses from paying too much tax because the officers have to recoup the bribes that they in turn have paid for their posting. The unwinding of such networks will be easier in GST, but it'll still take actual political will. An added dimension--which has escaped all attention--is that it's not possible for a business that pays tax to compete with one that doesn't. This makes a real cleanup of the grassroot level tax avoidance network all the more difficult. In fact, this will be the real challenge, especially because half the problem is spread across the states.

At the macro level, the downside of GST is the flipside of its upside. While the quantum can hardly be predicted, there's no doubt that GST will lead to an increase in the total amount of tax that the government sucks out of the economy. Here's the paradox. GST is not inflationary when you compare individual tax-paid transactions under the old rules with equivalent tax-paid transactions under GST. However, the movement of non-tax-paying transactions to the GST regime will doubtless increase prices of some goods and services. Beyond blind guesses, it is simply not possible to know to what extent this will happen, at what pace will it happen, and how it will balance out with other positive aspects of GST.

All one can say is that while the net effect will be positive, we are heading for some very interesting times.