Will GST help GDP growth?

Lokeshwarri SK BL Research Bureau | Updated on January 17, 2018 Published on August 04, 2016


Final standard GST rate, exemptions granted, compensations to States will determine the actual benefit to the economy

Adi Godrej, the most forceful proponent of GST, thinks that the GDP growth rate will soon be in double digit with the unified tax system. A study done by NCAER that explores the impact on growth due to reduction in direct cost and cost reduction on capital inputs pegged the improvement in growth rates between 2 and 2.5 per cent. Others have estimated the Indian economic growth between 1.5 and 2 per cent faster under the new tax regime.

While these projections can come true over the long-term, it is doubtful if there will be an immediate improvement in the growth rate of the economy. In fact, growth can slow down in the initial phase of the GST roll-out before the longer term benefits kick-in.

Negative impact in the short term

The primary reason why growth can be affected, at least in the first year, will be because the tax on services that account for around 60 per cent of the GDP, is expected to increase under GST while taxes on manufactured products that make up 17 per cent of the GDP can move lower. There is a typical tendency to prepone consumption if taxes are expected to move higher. But in this case, since most services are non-discretionary and since tax rates on goods can move lower, output can contract slightly following the roll-out.

A panel regression analysis done by Sonal Verma and Neha Saraf of Nomura on 11 countries for the period between 1961-2015 to study the impact of change in effective tax rate shows that for countries where tax rates moved higher, GDP growth picks up in the year prior to the GST implementation (year T-1), likely reflecting preponement of consumption in anticipation of higher prices. “This is followed by a temporary (though insignificant) negative impact on GDP growth due to weaker consumption in the year T, as firms pass on tax increases into higher output prices. Beyond that, growth does rebound, perhaps due to efficiency gains from a more streamlined tax structure and better tax compliance.”

However, there is a consensus among most economists that the GST will be positive for the economy over the longer term as it simplifies the tax structure, increasing compliance, reduces tax evasion, expands tax base and significantly improves the functioning of the logistics network.

Expansion of tax base

The GST regime ensures that the tax base for indirect taxes grows through two ways. One, it sets up a system of taking credit for taxes on inputs only if it has been declared and paid by the input manufacturer. This sets up a system of self-policing as it is in the interest of the producer to ensure that he sources goods only from those suppliers who are tax-compliant. Many companies in the unorganised sector who are currently not paying tax are thus expected to fall within the tax net.

Two, the committee set up to recommend the Revenue Neutral Rate (RNR) under Arvind Subramaniam, recommended an exemption threshold of Rs 25 lakh for goods. Currently, goods producers with turnover less than Rs 1.5 crore are exempted from paying central excise duties; at the state level, the exemption limit for goods varies between Rs 5 lakh and Rs 10 lakh. Decreasing the threshold for GST will therefore make many small manufacturers liable to pay tax on their products. Corporate tax data shows that entities recording revenue between Rs 25 lakh and Rs 40 lakh are paying a very small proportion of tax, though they are large in number. The threshold for services will however increase from the current limit of Rs 10 lakh to Rs 25 lakh.


The RNR report submitted in December 2015 makes the point that investments in the economy will improve “with a more seamless and efficient crediting of taxes paid on capital goods.” Currently, companies sourcing capital goods for capacity expansion cannot claim tax credit on capital goods purchased; this will change with the GST regime. The report says that capital goods prices would become effectively 12-14 per cent cheaper as companies avail tax credit. This is likely to increase investments and help growth. The report says that this could lead to incremental GDP of 0.5 per cent.

There is a long way to go and many hurdles to surpass before the GST becomes a reality. The final standard GST rate, exemptions granted, compensations to States etc will determine the actual benefit to the economy. It is to be seen if the bonhomie witnessed on Wednesday between the political parties continues to make the GST a reality.

Published on August 04, 2016
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