Impact of GST on the economy: 5 things to watch out for

The Goods and Services Tax (GST) came into effect on 1st July 2017. This happened after much anticipation and opposition. Now, one month has passed. Many are debating whether GST is delivering what it promised for the economy. It may be too early to measure its positive impacts. Those will kick in over the long run. But there are a few things to watch out for in the short run.

1. Compulsory invoicing

The small and medium enterprise (SME) sector in India is still unorganised to a large extent. Transactions often happen with partial or no invoicing. GST forces companies to ask their suppliers for invoices. They also need to raise invoices on their sales. GST also tries to do away with fake invoicing. It does so by introducing bilateral validation of credit or invoice matching. These steps can increase the compliance costs of small companies. It can also make their prices less competitive compared to the larger players. Large companies have better-established supply networks. So, they can offset the taxes they pay on supplies.

2. Supply chain reorganisation

Many SMEs are suppliers or service providers to a few large companies. This is especially true in the manufacturing sector. They come up around production hubs. Or you see them around the manufacturing facilities and warehouses of their customers. They have limited ability to diversify. What was the case before the GST implementation? Companies for the most part decided the location of their facilities. They based this on tax considerations. In focus were state taxes, along with location-based tax exemptions and benefits.

GST has made location-based tax neutral. It has changed the decision criteria for operational factors. These factors include logistical costs, storage costs, and proximity to key markets. So, large businesses are changing their locations based on these criteria. As a result, small businesses could lose their customers. Some have only a few customers. For this reason, they are unable to diversify. These small businesses could suffer the most. But new businesses could also come up where factories and warehouses relocate.

3. Anti-profiteering measures

The GST law includes anti-profiteering measures. Businesses now need to pass on all benefits of the new taxation system to consumers. This may happen through price reductions. The benefits include tax savings, as well as savings in operational and input costs. The GST Council will keep an eye on whether companies are passing on these benefits to consumers. Implementing these steps could be difficult. That is because indirect savings are hard to calculate. It could bring back an era of price controls. This will not be healthy for businesses, especially small ones.

4. Possible impact on household budgets

Essential goods and services are either exempted from GST or taxed at lower rates. These include food grains, consumer goods, healthcare, education, and transportation. So, inflation could remain low. This is good news for consumers. Companies are to pass on tax and operational cost savings to consumers. This will help consumers. The savings could lead to more household spending. This is positive for businesses. But there is more to it.

Non-essential services are taxed at higher rates under GST. This could hurt household budgets. Remember that services account for almost 50% of household consumption. This effect will not completely reflect in the headline inflation number. Services carry only 20% weight in inflation calculations using the consumer price index. Also, companies will in due course pass on tax compliance costs to consumers. This could further neutralise their savings.

5. Growth could stagnate in the short run

GST is a landmark move. It could bring the economy closer to the 10% growth mark. But this may not happen immediately. In the short term, economic growth could stagnate. Three major segments of the economy are being affected. These include consumers, big businesses, and SMEs. Analysts predict the economy to grow close to 7.4% in the financial year (FY) 2018. This is a bit higher than 7.1% in FY 2017. But it is much lower than 7.9% in FY 2016.

The road may be unstable in the short term. But GST could be beneficial over the long run. It could stimulate growth. What happens when more businesses enter the tax net? Tax policy becomes predictable and doing business becomes easier. Business sentiment could improve too. So, more foreign investors and companies could enter the country.