Service Sector & GST – Everything is not Fine

Service Sector & GST – Everything is not Fine

Since liberalization in 1991, service sector is in continuous expansion. It has been the main engine for growth from almost a decade. With more than 60% contribution to GDP, it is unexceptionally more significant than the other two sectors in terms of growth.  Reasons for this rapid growth are many. There are many economists & Industry experts who account the absence of counterproductive – higher tax rate, bureaucracy and state intervention for this high growth. These experts explain how absences of these counter forces in comparison to manufacturing along with the impact of globalization lead to this tremendous growth.

New Regime

Now India will see new indirect tax structure under GST regime which came to effect from 1st of July 2017. GST had already got the title for biggest reform since liberalization. There is little or no doubt that GST will be a big boost for the Indian economy as a whole. There are expectations for short term disturbances but these are accepted considering large scale transition. GST is supposed to bring lower compliance cost, encourage the single market, increase in tax revenues & boost economic growth. All these things said majorly in aggregate sense & at times with narrow view focusing mainly on the manufacturing sector.

What if GST leads to increase in compliance cost or suppress the growth rate of a specific sector? And what if that sector’s contribution to GDP is more than 60%? It will be worthy to watch how the interaction of GST & Service sector will take place.

GST and Service Sector

Service sector’s lower contribution to government tax revenues despite its huge contribution to GDP has always been in news. A section in government feels uncomfortable with this fact. With GST, they will get a chance to smile. All Major Service industries – IT & related services, Logistics, FMCG, banking, financial services will get a higher tax slab of 18% under GST. Also, a service provider who operates in multiple states like banking will have to register themselves in all the 37 jurisdictions (states & union territories). E-commerce companies will further face challenges with higher administrative cost because of their business structure. Hotels & Tourism industry will also be in trouble with 28% tax slab for AC restaurants and hotels. All these services earlier were under 15% tax slab. This higher tax rate & increased compliance cost will have a cascading effect on the performance of service sector.

Negative Impacts of GST on Service Sector

Higher tax rates suppress business and leads to lower tax compliance. In long term, a lower tax rate provides more benefits to an economy by boosting economic activity & higher tax compliance in comparison to higher tax rate. Also, higher economic activity & compliance also leads to higher tax revenues because of increase in base. This also increases employment level in the economy. Currently, markets are not in favor of higher tax slabs. Domestic as well as foreign demand is on a slower track. Under such conditions, higher tax slab & compliance cost will increase the input cost of the companies.

As the major cost of service sector companies (banking, financial, IT & related) is manpower, higher input cost will force companies to reduce their manpower. Thereby leading further to lower employment level, which is already a huge concern in Indian economy.  Another problem will be of scaling effect which is currently seen in the manufacturing sector. Firms will try to keep their scales down to avoid higher tax. This will also lead to increase in tax evasion. Although the sector will gain from input tax credits system which will allow companies to claim certain expenditure & thereby lowering their cost. However, this lowering of the cost wouldn’t be sufficient to balance an increase in cost due to higher tax rates.

Higher Tax Rate provides no solution

It is well acknowledged that service sector and specifically IT & related services have a spillover effect on other sectors also like manufacturing, mining. GST itself will need a huge IT platform for its GST network (GSTN). Various service sectors are also a huge employer to nation although not as large as agriculture or MSME. But at the same time wages on average are much higher in most of these service sector compared to agriculture or MSME. Therefore it plays a major role in stimulating demand which has multiplier effect on the economy. Considering these invisible advantages & current market scenario government should have kept the tax rate at the earlier level of 15% for services. The tax rate can be increased at a later stage. Focusing only on tax revenues with higher tax rates & ignoring other economic factors is not a viable tax policy.

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