Goods and Services Tax may slowdown the economy

A new era has dawned in the country with the implementation of Goods and Services Tax. Businesses will not have to pay excise duty, services tax and sales tax separately. These taxes have been merged into a single GST. Interstate trade will become easier. Goods can now be shipped from one state to another state without producing transit forms at the border. Credit of tax paid in one state can now be taken in another state.

These are revolutionary changes that will speed up the economy like good quality mobile oil helps speed up the car. At the same time shifting to the new system is bringing woes of transition. Thus the NIKKEI Manufacturing Purchase Managers Index slipped from 50.9 in June 2017 to 47.9 in July. The NIKKEI Services Purchase Managers Index slipped from 53.1 in June 2017 to 45.9 in July.

A PMI of more than 50 indicates that purchase managers are optimistic and likely to purchase more than previously and it indicates growth. A PMI of less than 50 indicates that purchase managers are pessimistic and likely to purchase less than previously and it indicates contraction. Contrary to the expectations, the Indian economy has moved from positive to negative territory after the implementation of GST.

The key question is whether this is a temporary dip due to compliance issues or a deeper long-term impact which may continue to pull the economy down in the coming months, even years. The answer will be determined by the long-term impact on small businesses.

The government has provided protection to the small businesses. Businesses having turnover more than Rs 5 lakh were required to be registered under the sales tax laws of many states. This limit has been raised to Rs 20 lakh. Small businesses having turnover up to Rs 50 lakh can opt for the Composition Scheme. They will have to pay a nominal GST of 0.5 to 2.5 per cent.

These are well-meaning measures. It is surprising therefore that Japanese Rating Agency Nomura has said that GST will lead to a shift of business from small to large players. Top Indian rating agency ICRA has said that the informal sector will find it difficult to compete with the formal sector under the new arrangement. These warnings are based on three negative impacts of GST on small businesses.

The requirement of returns is cumbersome under the GST regime. Previously small businesses had to file only one return every quarter under the sales tax laws. GST requires a monthly return to be filed. This return requires information to be uploaded on the GST portal three times during the month. Thus effectively, a small business has to fill three forms every month or nine forms every quarter.

Many small businesses do not maintain daily accounts. They fill in the quarterly returns on the basis of estimated sales. They also do not have expertise to upload this information on the GST portal. They do not have the time or income to engage a chartered accountant to comply with these requirements.

Big businesses have an army of in-house chartered accountants who can undertake these compliances. Hence the small businesses will be burdened with additional financial burden and will lose to big businesses.

GST will make it easier to undertake interstate trade. Most interstate trade is undertaken by large companies. Previously, small businesses had a natural protection from interstate imports because of the difficulties in such trade.

The smooth flow of goods between states will eliminate this natural protection. A curtain maker in Haridwar, for example, had a natural protection from big companies located in Ludhiana. Curtains from Ludhiana will easily enter Haridwar and provide increased competition to small businesses.

The GST regime allows purchasers to take credit of the GST paid by their suppliers. Big companies that pay GST would prefer to buy goods from suppliers who are paying GST so that they can take refund. A small stationary dealer supplying material to the big companies comes under the exemption of Rs 20 lakh hence he does not pay GST.

However, the big company buying stationary from him will have to raise a ‘self-invoice’, deposit GST on the purchase as if it was paid by the small supplier. Then take credit for this amount when it files its monthly return.

This imposes an additional burden on big companies buying goods from small traders. They would rather buy stationary from bigger dealers and avoid these hassles. Similarly, credit cannot be taken for the 0.5 to 2.5 per cent nominal tax paid by small traders opting for the Composition Scheme which will make them uncompetitive. Nomura and ICRA are saying small businesses will be negatively impacted for these reasons.

These impacts on small businesses are of a long-term nature. The burden of filing a number of returns, increased competition from big businesses due to smoother interstate trade, and less demand for small businesses due to the system self-invoice will cripple the small businesses in the long run.

That still does not mean that the economy will go into the negative territory because the loss of small businesses will be the gain of big businesses. The economy could even be benefitted because big businesses will supply cheaper goods.

But there is another aspect of the matter. Nearly 80 per cent of employment in the country is generated by small businesses. Trouble for small businesses will therefore translate into less employment; less income earned by the common man, less demand for goods such as clothing and footwear in the market, and pull the large businesses down with the small businesses.

This can push the larger economy into a slowdown just as happened with demonetisation. The benefits of GST thus could be undone. The government must wake up to this lurking danger immediately. Small businesses must be exempted from filing 9 returns every quarter. Small businesses must be allowed to take credit for GST paid by them on the purchases even though they do not pay GST on the sales.

This will enable them to stand up to the influx of goods from other states. The provision of raising a self-invoice for purchases from unregistered dealers must be scrapped. Author was formerly Professor of Economics at IIM Bengaluru

By Dr Bharat Jhunjhunwala