Understanding GST and savings in the economy By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

August 11, 2016 | Posted by bobbysrinivasan << back to blog

After almost a decade, the Indian parliament passed a low introducing GST to be applied across India on a uniform basis for all goods and services traded. The parliament has yet to resolve as to whether one GST rate will apply or multiple rates depending on national objectives and priorities. Further it is believed that GST will become applicable across India from April 1, 2017 the new financial year. This is a conversation between a student and his professor.

Student: Professor, I read in the papers that our government has decided to implement the GST replacing various sundry taxes such VAT etc. It is good for the economy?

Professor: The Finance Minister has said that it will add 2% to our GDP in the long run. India’s current GDP is 2 trillion dollars. 2% means Indian economy will gain by 40 billion dollar. This is not an incremental wealth creation but a wealth transfer from the people to the government. You see in India’s federal budget has nearly 5.3 trillion rupees of deficit. This will facilitate the government to reduce its deficit because of this new bounty.

Student: You are saying that this a zero sum game. What would be the impact on GST on citizens?

Professor: You learn in Macro-economic Y = C + I + G + (X – M). Since this is a wealth or capital transfer to the government C’s position will be altered, if C maintains his or her consumption this extra tax will reduce his or her savings. Already the Indian savings rate is falling appallingly due to inflation and so this increased tax will not help the situation. On the other hand if the citizen/s decided to postpone consumption he will create a recession. This is exactly what happened in Japan. Japanese government decided to push up their GST from 8 to 10% to reduce their budget deficit. Consumption got hit hard and the deflation become even more severe. Realising the mistake, Japan postponed the implementation of higher GST.

Student: What then is the real situation in India?

Professor: Hard to say. The government expenditure will definitely go up and this will add to the GDP. Consumption may take a hit. Demand use of money will change among people. I noticed this in Canada. When a 15% GST was levied, people postponed purchase of car, fridge and other capital goods. This made the economy slowdown.

Indian citizens’ honestly does not understand as to what 18 to 20% GST will do to their consumption and savings. This will particularly cause severe pain among the middle income group. Follow these equations carefully,

Net Salary = Gross Salary – Income Tax

Consumption = Function of (net salary, borrowing through personal and

credit card loan)

Savings = Net Salary – Consumption

This clearly shows that either savings or consumption will be hit. As far as the government is concerned, indirect taxes is the best way to collect money from rich farmers who will be using their income and wealth in consumption. This becomes an additional source of income for the government. The state government will be happy because the Central government will share the excess goodie.

Student: It is clear to me as to how my disposable income will be affected by the GST. Given that I carry a bank loan for education my net income may not be sufficient to meet my obligations. It is clear to me that GST is incremental revenue to the government provided by its citizens. This is pure expansion of government. They have never done a good job and this extra money will disappear through some subsidy.

Professor: It is a great victory for government. This will eliminate or reduce black money in circulation. The states will be happy because they will get a share of the pie. The procedure will be grossly simplified. For the consumer he will know his final cost with clarity. The government will realise that 18 to 20% is too much GST rate, because it will hit consumption. Visualize in a village; there are two parties, one who wants to buy a cow and the other seller. Imagine their reporting a trade with the GST collected from the buyer and the money sent to the government though commercial bank. Imagine a retail outlet selling goods based on MRP. MRP is only a suggested price. They can for example lower the MRP and collect the 18% on the lowered value.

Student: I see your undertone and point. Thanks Professor.

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