Overestimating the effects of policy reform?

Mr. Vijay Kelkar, Chairman Finance Commission, recently delivered the convocation address at the Indira Gandhi Institute of Development Research. The speech largely addressed itself to the benefits that a Goods and Services Tax (GST) would bring to the economy. While the benefits of GST need no reiteration(the speech itself makes a cogent case), the figures that Mr. Kelkar puts out seem suspect. He argues that there can be a saving of 1.4% of GDP which translates to $15bn annually. He then proceeds to discount it at 3% to yield an NPV of $500bn.

The question to ask is why use a discount rate of 3%? Unless we argue that the nominal interest rates will average these levels over the next several decades, the case for using such a low interest rate is not clear. In fact, using a 5% rate reduces the implied benefits by more than 50%.

Another area where I find myself skeptical is the contention that more services will get taxed under GST. It appears to me that most services are already being taxed now - banking, telecom, brokerage, consulting etc. Large value services that do not get taxed are largely those that are provided by the government - say the railways. Even these can be viewed as being taxed, since railways are a department of the Central Govt and not a company. It appears that the net addition through taxation of services may not be significant - though I have no estimates, and may therefore be in error.

The downside of GST is often higher prices, lower private consumption. This too is a cost that needs to be kept in mind. As also, the fact that in ensuring that all states agree to the proposals, it is more than likely that GST will not be introduced in the true spirit, and States will continue to impose some form of Octroi or other local taxes. This will again kill the purpose of GST.

In all, the simplicity of the concept itself makes it worth implementing - despite the much lower than projected benefits that may arise.