GST and currency ban

December, 2016

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V.S. Krishnan

In the first two and a half years of this government, the common refrain was that reform has been incremental rather than radical. That perception has been punctured by two big-bang measures. The GST, which was a reform in the works, has been given a big boost by the government through building a broad political consensus on a number of thorny issues. The demonetisation measure was, however, a surprise announcement which has set the cat among the pigeons. Many economists have argued that the demonetisation announcement could extract some collateral damage in the form of a delayed GST implementation.

This is not true. In fact, both are complementary measures. While demonetisation attacks the stock of black money income, GST addresses the flow problem by bringing in transactions carried out in the informal sector to the formal sector through a number of measures like an IT-based transaction-tracking system. Importantly, demonetisation could aid a smooth transition to the GST by fast-forwarding the digitisation of transactions. An opportunity has also been created to nudge small businesses into a regime of cashless transactions.

The GST initiative is being underpinned by technology support from the GST-N (a special purpose vehicle created for implementing the GST technology project) which has created a common portal for all transactions. It is expected that 7.5 million business entities will come within the ambit of GST and all of them will have to submit their business transactions online. Demonetisation, on the other hand, is a ‘gale of creative destruction’ which may, contrary to conventional wisdom, help the GST implementation by encouraging digitisation among the small businesses/trading communities.

The states’ worry about compensation is also unfounded for this is linked to the revenue base of 2015-16, a period not affected by demonetisation.

Another dimension of demonetisation is the behavioural change that is likely to happen. Small businesses and merchants are slowly getting reconciled to cashless payments. Many of them have started installing Paytm and card-swiping machines. This is being supplemented by another effort to increase the number of Jan Dhan accounts across the country. Already in the last two years, more than a 150 million Jan Dhan accounts have been opened. This massive exercise in financial inclusion will ensure that the unbanked segments will now enter the financial mainstream. To aid this process, mobile phone manufacturers would also have to reengineer their applications so that they can move into an Aadhaar-enabled platform where fingerprints can be identified.

Transitional disturbances are only to be expected when the country embarks on such a massive reform. Many have suggested that such steps should have been taken incrementally after requisite preparation. Sceptics must understand that transformational changes are not made by demonstrating caution. A good example is how Abraham Lincoln passed the Lands Grant Act, 1862, that provided land grants for setting up private universities (laying the base for the pre-eminence of American universities today) during the height of the Civil War when Confederate troops had almost reached the gates of Washington.

Finally, demonetisation and GST acting in tandem may deliver a new higher normal for the tax-GDP ratio by pushing it from the current level of 16-17 per cent of GDP to 20 per cent in the medium term by formalising the informal sector. This would considerably enhance the financial capacity of the government to deliver basic services to the people.