Government Crackdown on Black Money Puts GST at Risk

Fri, 23 Dec Pre-Open

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Could one game-changer move end up seriously impairing another?

Will the Modi government's demonetisation move affect the way the goods and services tax (GST) regime plays out?

The Modi government already had its work cut out finalising the GST deal with 29 states. And now this decision to scrap 86% of the cash in circulation, in a bid to purge the economy of 'black money', has triggered more disruption.

It has caused the revenue of state governments, which collect value-added tax on goods and other duties, to slump by 25-40%. The states will be wary of risking another setback by rushing to enforce the sales tax.

There are various estimates about the impact of demonetisation on demand and growth, as also about how long these effects will last.

Per the finance minister of Kerala, T.M. Thomas Isaac, demonetisation has created a trust deficit between the center and the states, which is a huge setback considering it took Modi more than two years to forge a political compromise on the tax in August.

This deadlock could tip India into a fiscal crisis. The lingering uncertainty has companies worried about financial implications of the new tax.

The states' revenue collection comes from commercial taxes, state excise duty, motor vehicle tax, land revenue, stamp duty and registration which has not been adequate. This has led to increased dependence of states on central funding. In 2015-16, the ratio of central transfer to states' total revenue was 70.71%.

The finance minister has already agreed to cover states' revenue losses for five years after the GST's launch, but further concessions would restrict him severely in his next annual budget.

Besides loss of revenue, some states are worried about the social and political costs of demonetisation.

Odisha's chief minister recently wrote to Modi saying restrictions imposed on primary agriculture societies were making it difficult for farmers to access crop loans and procurement payments.

Some states have hardened their stance on how to collect the new GST. They want sole control over businesses with annual turnover of 15 million rupees (US$220,000), and so-called 'dual control' over bigger firms. Jaitley opposes this, fearing tax collectors could end up at cross purposes.

But can the government wait for the economy to settle down before moving into the final stage of GST?

That seems unlikely. The Modi government's prestige is at stake - this is, after all, one of the big bang reforms it can claim credit for before the 2019 election.

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