Amid the demand for more spending, lies a less scrutinised proposal by the CII. Its president recently suggested temporarily slashing GST rates on consumer goods by two to three percentage points for at least six months to boost demand
As India emerges from a brutal second wave of Covid-19, stakeholders are demanding a generous fiscal stimulus to repair the battered economy. Last week, finance minister Nirmala Sitharaman announced a ₹6.2 lakh crore credit heavy package for several sectors; many wanted more.
Amid the demand for more spending, lies a less scrutinised proposal by the Confederation of Indian Industry (CII). Its president recently suggested temporarily slashing Goods and Service Tax (GST) rates on consumer goods by two to three percentage points for at least six months to boost demand. A temporary but broad-based reduction in VAT rates was deployed by the United Kingdom after the 2007-08 financial crisis, and quite successfully so. Recently, some economists have also backed the same proposal for India.
The rationale
A GST cut is like a reduction in income tax rates as both leave individuals with more money to spend on purchases. Crucially, however, sales are more likely to pick up after a pre-announced temporary tax cut because it incentivises households to draw purchases of durable goods forward.
Unlike cash transfers, benefits from this policy cannot be hoarded. It is quick to implement. Moreover, a GST reduction will benefit all sections of society, including the middle-classes. A 3% cut across all slabs may also close the door on corruption and inefficiency-prone lobbying by sectoral pressure groups.
For all these reasons, a short-term indirect tax cut is a good idea. But there are other less flattering aspects to it.
The critique
Given the unknown trajectory of the pandemic, it might be infeasible to hike rates back to present levels a few months later. The economy could be badly hit if the holiday expires exactly when fiscal stimulus is most needed, perhaps due to a possible third wave towards the end of the year.
But if people think the government would renege on its commitment, or if they make the change near permanent from the get-go, it will not only be more expensive (a three percentage-point cut in average GST rates may cost 0.8% of GDP) but do little to stimulate the economy. Individuals can simply delay expensive purchases until uncertainty abates.
Sellers may also avoid passing on the GST reduction to customers. This will depend on their capacity to cater to higher demand, as well as the competitiveness of the various markets. For some items whose sales are less responsive to prices — and that may be a long list because lockdowns reduced even some luxuries into necessities — a tax cut will just be a transfer from the government to sellers, without much impact on sales.
But equity-related concerns are even more significant.
India’s untaxed informal economy suffered disproportionately due to the pandemic as more formal, internet-based sellers gained market share. Using a GST cut as fiscal stimulus will further hurt competitiveness of a sector that still employs most of India’s workers (more so if people are reluctant to spend outdoors and try to encash the tax holiday online). An indirect tax reduction may additionally be a regressive transfer in so far as poorer households spend a higher proportion of their incomes on tax-exempt products such as food.
The alternative
If not this, what can the government do to revive the economy?
A seminal result of public economics is that taxes on production are more inefficient than those on consumption. The Centre can make the first move by slashing its high duties on fuel to dampen inflation and stimulate economic activity. Reducing these input taxes will also benefit informal producers and increase profit margins for badly hit groups such as transportation workers.
There are more ways to benefit unorganised suppliers. Recently, East Delhi’s municipal corporation waived off market fees for vendors until March 2022, reportedly saving each seller at least ₹3,000. The Centre and states should encourage local bodies that deal directly with people to come up with more such citizen-centric decisions and back them financially when they do so.
Reducing taxes on inputs is more efficient and equitable than a GST cut on consumption. Yet, cross-country evidence and common-sense dictate that quickly bringing the pandemic under control remains our most powerful fiscal lever. Growth projections made on either side of the second wave suggest that the Delta variant could have knocked off at least 2% off GDP growth numbers for FY 2021-22, amounting to over $60 billion in lost income, though, to be sure, this is a tentative and early assessment, subject to revision. But for reference, this is equivalent to what India spends annually on defence.
If they are in the mood, however, several areas can benefit from a jugalabandi of the health and finance ministry. Spending more on vaccines, including on ordering promising candidates in advance is a bold move that New Delhi has only recently seen merit in. Providing vouchers to the poor for getting jabbed in private institutions will help reduce vaccine inequity. Similarly, steps such as Chhattisgarh government’s decision to subsidise expansion of private healthcare capacity in rural areas will not only save lives, but also protect incomes. As hospital occupancy rates rise to dangerous levels, even the most economic-minded governments will have no option but to impose stringent lockdowns.
Stronger pandemic defences, robust health care systems, and an increasingly vaccinated population will almost certainly ensure stronger growth numbers. But if demand remains muted as normalcy returns, governments can revisit spending options. For now, they must realise that any penny pinching on responding to Covid-19 would be fiscally contractionary.
Sarthak Agrawal is a researcher with the Poverty & Equity Global Unit at the World Bank.
Hamish Low, Professor of Economics at the University of Oxford, gave inputs
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