Why Modi’s GST move misses the real economic problem
The Indian government has announced a rationalization of the GST on a slew of products and services. Many observers, including investment banks, have concluded that this will lead to a boost in consumption.
While any simplification and rationalization of taxes are always welcome, the conclusion that a reduction in specific taxes will lead to increased private investment/ consumption is incorrect. It is a widespread misconception that arises from a flawed understanding of government finances.
Let me start with the Universal Axiom – The cost of a government to its citizens is not what it taxes, but what it spends. This is a fundamental yet often overlooked principle. Let us assume there are four taxes – call them A, B, C, and D that contribute to government expenditures. Would reducing any one specific form of tax, let us say “A”, result in an overall reduction in taxation for citizens if government expenditures remain the same?
Obviously not. If the government reduces Tax “A”, then by definition, it has to increase one or more of the other taxes to compensate for a reduction in revenue that arises from reducing Tax “A”. Unless a reduction in Tax “A” is accompanied by an equivalent decrease in government expenditures. Only under such a condition would a reduction in taxes lead to an increase in private investment/ consumption. This is an inviolable law of economics.
So let us now return to the four taxes. There are various taxes that we pay – income tax, GST, customs, tariffs, corporate tax – the list is almost endless. And it is to be remembered that ultimately, all taxes (even if it is paid by companies in the form of corporate taxes) are, in one way or another, borne by citizens. Let us group all these into three categories and label them A, B, and C in the example above. The fourth and the least understood Tax, “D”, is the “Inflation Tax”. This is a self-adjusting tax, representing the difference between what the government spends and what it collects in the form of Taxes.
So here is another inviolable and yet misunderstood axiom. The Inflation Tax equals the difference between government expenditures and government revenues. Let me summarize these into a few points for ease of understanding.
Let us now discuss the above in the context of the Indian Union government finances. For FY2025, the Union government expenditures was Rs.48 La Cr and the government revenues was Rs.31 La Cr. This difference, i.e., Rs.17 La Cr, is the “Inflation Tax” paid and manifests itself in the form of higher fuel, food, and service prices.
I don’t want to make it too complex, so let me simplify it for easier understanding. Assume the proposed rationalization of GST had been done last year, and the taxes were lower as a consequence, and were only Rs.30 La Cr. What this would have implied is that the Inflation Tax, instead of being Rs.17 La Cr, would have been Rs.18 La Cr.
So, we might have sold more tractors, but the poor would have consumed less food due to the increased prices. Or the middle class would have had to reduce their educational/ medical expenses due to the increased prices of these services.
If Prime Minister Modi is interested in genuine solutions and not merely rearranging the deck chairs on the Titanic, then he must look beyond his Economic Advisory Council and draw inspiration from the chainsaw he witnessed in Buenos Aires.
Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.
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2. Returned to India in 2005 and have been an investor ever
since
3. Focus on investing in precious metal equities, particularly Gold, Battery Metals and Uranium Juniors.
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