Riddle of high indirect tax collections & low GDP growth

One may be surprised at the slow rate of seven per cent economic growth in the first quarter, despite a 35 per cent growth in indirect tax collections and softening of international commodity prices resulting in slow growth of subsidies.

The curiosity might be further compounded by the fact that 7.1 per cent rise in gross value added (GVA) yielded such a low growth in the gross domestic product (GDP).

On the other hand, 6.1 per cent GVA growth had delivered 7.5 per cent GDP expansion in the fourth quarter of 2014-15.

The devil lies in the new methodology of GDP calculation.

At the outset, the new methodology not only changes the base year from 2004-05 to 2011-12, but also considers GDP at market prices which include indirect taxes and exclude subsidies. Earlier, GDP at factor cost, excluding indirect taxes but including subsidies, was considered.

Now, there is no concept of GDP at factor cost. Instead, GVA, a sum total of agriculture, industry and services at basic prices, is there. GVA includes indirect production taxes such as electricity tax and excludes production subsidies. On the other hand, GDP includes indirect product taxes such as excise duty, customs duty and service tax, but excludes product subsidies.

In these times, when indirect tax collections rose 37.5 per cent in the first quarter of the financial year, GDP growth was less than even GVA.

This is so because there is no link of this huge growth in indirect tax mop-up and real GDP growth (adjusted for inflation), explained Ashish Kumar, director-general, Central Statistics Office. On the other hand, nominal GDP growth would reflect these indirect tax numbers.

That is why, a 7.1 per cent rise in nominal GVA resulted in 8.8 per cent rise in GDP in nominal terms in the first quarter of 2015-16.

For real GDP, price deflators are not used to arrive at indirect tax collections.

In the earlier methodology, it was used, but the International Monetary Fund (IMF), which prescribes standards for national accounts, criticised this practice as the government move to raise tax rates would result in higher GDP. It is another thing that GDP at market prices was not used then.

To get real GDP from GVA, indirect tax collections are arrived at using a fixed ratio. The ratio was fixed at the base year of 2011-12. This ratio is value of goods and services including imports divided by indirect taxes in 2011-12, Kumar said.

This ratio is used to get indirect tax figures for the subsequent years by dividing the value of goods and services with it. Similarly, for 2015-16, this ratio was used and not the 37 per cent increase in indirect taxes. So the rise in service tax rate to 14 per cent from 12.36 per cent from June this year as well as extra measures taken by the government such as increase in excise duty on petroleum in four phases from October last year, removal of excise duty sops on auto and capital goods sector would not reflect in GDP growth.

IMF wanted real GDP growth to represent growth in volume goods and services and not these measures.

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