What went wrong with GST? – a useful discussion

Friend #1

I think Jaitley is being unfairly blamed for the plethora of rates. Every State Government had a pet commodity on which it didn’t want a reduction in rates. Partly it was fear a reduction in revenues and partly it was political. The GST rate on AC restaurant was a classic case of being politically correct and fiscally stupid. There was a built in revenue buoyancy in that the Idly at the Taj was always going to be a good deal more expensive than the street corner Udupi restaurant. The AC non AC distinction was thus unnecessary for GST purposes. It was Chidambaram who introduced a higher Service tax for AC restaurant in his 2013 budget. Now, rationalising the tax structure for restaurant service would have reinforced the image of ‘suit boot ki sarkar’ which this Govt wanted to avoid. Moreover in the interest of federal consensus the Centre humoured each State Government on its pet peeve. This was a conscious political decision for which the FM
alone can not be blamed. That said, the CBEC had its own axe to grind.

They didn’t want an altogether simpler tax structure. Jaitley couldn’t or didn’t have the gumption to overrule his officials who were constantly painting a picture of fiscal collapse.

My reactions:

But, somewhere, the buck (or, is it actually a bug, in this instance?) has to stop. Yes, States were reluctant participants for many reasons. Partly, it was about revenues for the State and partly it was about rent for the officials. Someone – and it has to be logically the leader of the whole initiative – should have risen above all these considerations and arguments and seen the big picture and have used all his rhetorical and logical skills to persuade them to go with a simpler structure from day one so that compliance is encouraged and incentivised.

Given that states were given 5-years of revenue loss compensation, then he assumes even greater moral right to articulate and ‘impose’ a vision of the above nature.

I am repeating myself: policymaking is also entrepreneurship. One must take one’s chances, at least from time to time. The GST called for such an entrepreneurship.

It has to be said that the government had proven itself to be poor in the execution of GST and the Demonetisation exercise. Of course, the latter is opposed even conceptually by many. That is a different issue.

Against this, they have a good one in the PMJDY. So, the score line is 1-2 in their favour.

Friend #1 responded:

(2) Viewing it purely through the management spectrum, this is what occurs to me on GST and demonetisation. On GST, it is principally the ‘treason of the clerks’ (to use a phrase made famous by Jagdish Bhagwati). The bureaucracy set up this Government nicely, to take a mighty fall. I mean how else can you explain a GST rate structure that had something like 13 rates? I am including those different ‘GST compensation cess’ rates for specific commodities, to the many basic rates of GST, in this context. For the bureaucracy the motive was fighting to stay relevant in the post GST regime. In the medium to long term the CBEC and the VAT administration at the State level would be rendered redundant (my guess is about 90% of the staff would not be needed). On the  other hand, you could argue with equal force that the top manager (PM/FM) knew that there would be resistance from the bureaucracy (or subordinates) but he might have thought that giving the clerks the impression that they are setting it up to fail might have secured better cooperation than doing something that would have invited complete recalcitrance. The odd civil servant can be made to fall in line. But if the whole system digs its heels in and refuses to move, there is not much that even the most powerful CEO can do in such a situation. The course correction that we are seeing now is perhaps part of that process.

On demonetisation, there were two issues. One was the obvious mistake- not realising in advance that ATMs are not calibrated to handle currency denominations of completely different dimensions to the existing ones. In every strategic decision you cannot factor in all possible consequences. There will always be the ‘unknown unknowns! The ATM problem falls under this category. But not ramping up production of new currency notes is total managerial failure. We now know from news reports that have surfaced in recent times that preparations had started in early April or May or perhaps July. It is possible that everyone along the chain went through the motions thinking that this won’t happen. Only Modi knew otherwise.

Friend #2

XXX gives much more credit to the bureaucracy than it deserves. We often think that Ministers are easy fodder for the wily bureaucrats. Trust me, it is rarely the case. I have been involved in the process of bringing VAT to the States a decade back. People do not remember it now, but the process had similar hiccups. Since it was at the State level, the media glare was not so much. Moreover, there were different experiences in different States, ranging from excellent to shoddy.

Different tax rates is quite normal in the multi-partisan polity like ours. As Sampath himself admits, every State had a pet peeve. Insisting on a single tax rate at that point, or even on 18% ceiling would have been a deal-breaker. Jaitley knew that, as also the Congress. Top Congress mandarins never wanted GST, but had to give in to the political realities. Jaitley deserves great credit for using his deep connections to fool the Congress mandarins to push the Constitutional Amendment through. Nobody else could have managed that.

The mistake was committed at the implementation level by keeping CBEC in the driver’s seat. CBEC had no experience in handling the small traders, who constitute 90% numbers but only 5% value, whereas the States had great experience in dealing with the small traders. Small things like using the Excise codes instead of the VAT codes have created so much confusion at the ground level that could have been avoided if Adhia had used the State officials more than the CBEC mandarins. Even the earlier insistence on monthly returns, and then the mismatch in quarterly and monthly returns is due to CBEC’s ignorance of VAT procedures.

All in all, it is a good thing if mistakes are being pointed out and being quickly addressed. Rahul Gandhi has woken up late as usual, but his party fully cooperated in passing the Constitutional Amendment.

Final remarks from me:

If you do not read Indira Rajaraman on India’s fiscal policies – whether on  GST or on demonetisation – you are missing something. Her recent article in MINT (published on Nov. 3) can be a case study for management students, for budding bureaucrats and for economists. It is a very important article. I cannot say it often enough and loudly enough. Just a sample here:

I still maintain that the principal reason why GST reduced economic activity had to do with the reporting modalities, not the brambly rate structure. But the rate structure was and continues to be a problem. It has undermined the very principles on which the tax reform process was built seamlessly across successive governments at the Centre, the most fundamental of which was simplification….

…. Any tax reform has to facilitate business in order to secure revenue and willing compliance. Such a configuration for the GST is still possible if the reporting frequency is shifted to quarterly for all, and voucher matching is restricted to IGST transactions.

The highlighted sentence is what I have been calling as ‘policy entrepreneurship’. What is the point of introducing a single tax if the objective was not to create a single market and facilitate better and more economic activity. It boggles and disturbs the mind to find that no one inside the government seems to have thought of that angle at all. Did they think that it would happen automatically and that they could simply pile on their burdens?

Indira Rajaraman’s article is an indirect indictment of the jump in the ‘Ease of Doing Business’ rankings for India. On that topic, read the column by Shankkar Aiyar.

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5 thoughts on “What went wrong with GST? – a useful discussion

  1. Good post. Agree with many points which both you and your friends make. I would like to make one point. Let us not assume that ambiguity is not sought after by people who pay taxes too. Private Sector also has an implicit backing for the different rates in the proposed GST structure based on different competitive reasons as well as their tendency to avoid taxes as much as they can, if they can, by manipulating the system to their advantage. It was not just the bureaucracy’s apple cart being threatened, a whole lot of businesses would have nothing to do if a pure GST would have been implemented. To that extent, they succeeded at least temporarily to bring in an imperfect GST.

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    1. Thank you, Aditya. I understand what the private sector would prefer. That is a good point. I am sure ambiguity helps gaming – on both sides. But, if the government were clear, it could resist them. Further, other decisions surrounding the introduction on invoice matching, monthly filing suggests that there was risk aversion on the side of the government more than the preference for ambiguity on the part of the private sector. But, point taken.

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      1. Ananth, Your points about risk aversion is completely valid. But then that’s why they are in Government and not in business, isnt it? Monthly filing may be onerous and moving to a quarterly/half yearly filing has already been thought of I suppose. But, I think Invoice matching is going to be a game changer in the days to come as the dust settles down. It will push people to adopt technology, systems and make life generally easier for both tax payer and tax collector. It is in fact one of the critical steps to avoid ambiguity and gaming the system. Today’s confusion is because it is a change that threatens the way you do business and the inability/inertia of people to respond to that change.

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  2. Indira Rajaraman’s articles have been the most deeply researched, informative and enlightening on GST implementation, she was the first one to raise the problems in Invoice matching also.

    “Policy entrepreneurship” as you define nicely has been solely lacking in the present Govt. I would say a variation of Hanlon’s razor defines the problems – Never attribute to others motives or malice that which is adequately explained by own stupidity. (;-)

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  3. Doesn’t the “brambly rate structure” encourage corruption by tax inspectors? Who is going to decide that the proper tax rate was applied? One measure on which every policy should be judged is the amount of discretion available to govt in implementing policy as well as state capacity required to enforce, etc. That is usually the source of corruption.
    In a similar vein, a lot of demonetization corruption has occurred due to corruption by inspectors and bank officers, which should have been expected and avoided by policy design. This corruption then funnels up to politician corruption as well.

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