Mar 20, 2018

GST long term positive for tax collection - More evidence

Image of GST effect on tax compliance
GST effect on tax compliance

Yesterday, Bibek Debroy commented that it might take around 10 years for the GST to settle down. That might be so, but some effects might start showing quite early. One of the effects I am very keen to see is the effect of computerised invoice matching between suppliers and recipients.  This matching should ideally eliminate mis/under invoicing over a period of time as the participants in the value chain realise that compliance is better than the efforts required to maintain informal accounts, and is not commensurate with the risks associated. This effect, I felt all these days, should not take more than two years. Two years should be the rough time period when a new system rolled out at a scale of our country emerges out of the teething troubles. Or so was my hunch. 

Looks like the period indeed is around that much as per this NBER working paper by Fan, Liu et al.  It is a study of effect of computerisation of VAT in China during early 2000s. The study found that most of the good effects of tax increase due to computerised invoice matching are found in first three years before stabilising onwards. In terms of growth, this study of 7 years data post computerisation summarises thus: 
"In terms of magnitudes, the estimates imply that computerization caused the effective tax rate to increase by 4.7% in the short run, 14% in the medium run and 11.7% in the long run, from 4.95 to 5.19-5.65 percentage-points, and explains 14.38% of all VAT revenues during 2001-2007. Thus, the effect on government revenues is sizable."

The formalisation of economy is an important side outcome of invoice matching through computerisation. The paper uses a method similar to difference-in-difference (DnD approach was also used recently in our economic survey to isolate the effect of export incentives on textile sector). It appears to me that the study has done a good job at eliminating confounding factors such as economic growth post WTO and sectoral effects. It is a good read and the results seem directly transferable to Indian context. 

Another insight from the paper is that the compliance in indirect taxation had no spillover effect on other forms of taxation. So those expecting a corporate or income tax windfall might be disappointed: 

"An interesting question is whether strengthening the VAT information chain had positive spillover effects in the enforcement of other types of taxes. We examine corporate tax payments, which are also reported in our survey data. Table 8, column (1) shows that the interaction coefficients are positive but statistically insignificant. Thus, there is no evidence of positive spillovers.
The result on corporate tax is also interesting for another reason – it provides evi- dence against the concern that our main finding that computerization increased VAT is confounded by general improvements in tax enforcement."

Did the firms export more to avoid VAT as exports VAT paid is rebated? The papers says that no such effect was statistically present. So the domestic taxation didn't drive the participants to turn exporters. 

In the end, the simple effect of computerisation (or computerised invoice matching) seems to be that it increased the compliance and tax collection by bringing in more formalisation. That alone would be a significant achievement for GST. Three years are not that long. Mr Debroy should agree.