GST, the new tax regime, has brought with it a lot of anxiety in terms of implementation. Even in midst of all the uncertainties and challenges, there is confidence that in the long-term it will lead to benefits in the form of higher GDP growth and wider tax base. However, the pertinent question currently is what could be its impact on inflation.
As per the GST tax rates finalised, nearly 50% of the goods fall under the 18% tax rate. In the earlier indirect tax regime, for many items, excise duty plus state VAT and all other taxes added up to more than 25%. Hence, for many of the manufactured goods prices should fall under GST. Under GST, for all goods and services, the producers can claim input tax credit. This means that at the time of paying tax on output, producers can reduce the tax they have already paid on inputs. In the earlier regime, many of the taxes like CST, entry tax, octroi and several cesses were not vatable. This resulted in cascading effect of the taxes. Removal of cascading effect under GST should also help reduce prices.
The government has introduced an anti-profiteering law under the GST bill to ensure that the benefit due to a reduction in the rate of tax or from input tax credit is passed on to the consumers. While theoretically, prices should go down for many manufactured products under GST, in reality, there could be stickiness in the downward revision of prices and the anti-profiteering law may not be easy to implement.
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There is an apprehension of inflation in the services sector. The services sector contributes more than 50% to India’s GDP. The GST rate applicable on most services is now 18% as compared to 15% under the older tax regime. This will put upward pressure on prices in the services sector. Service providers will get input tax credit for goods as well as services purchased by them, which will to some extent help in reducing service cost. However, another aspect to be taken into account is that for many of the service providers like banking, insurance, telecom the compliance cost is going to increase under the GST. Under GST they will be required to do state-level registration, whereas earlier the registration was only required at the central level. This will add to the cost of the service providers and mitigate some benefits of the input tax credit (ITC).
While the anti-profiteering clause says that the service providers have to pass on the benefit of ITC, again it may not be easy to implement. In the last few days, service providers have been intimating their clients about the increase in tax due to GST, but there is still no clarity on reduction in service cost due to ITC. We have to take into account that there are many small/unorganised players also in the market, hence keeping a track of reduction in cost due to ITC could be difficult.
Another aspect to be taken into account is that many items are not yet covered by the GST. Potable alcohol, crude oil, natural gas, aviation fuel, diesel, petrol, electricity and real estate are currently out of GST, and states will levy their own taxes on these. Take the case of petroleum companies, their final output petroleum products are out of GST. Hence, the amount of GST that petroleum companies pay on the hiring of rigs and purchase of equipment and services for crude oil production and refining cannot be offset against the tax paid on the final products (as petroleum products are out of GST and will continue to be covered by central excise duty and VAT). The resultant increase in cost for these industries could pose an inflationary threat.
GST will result in some non-productive expenses like logistics and warehousing cost going down. This is because taxes on inter-state movement like entry tax and CST will be subsumed under GST. However, this cost reduction by the producers many not necessarily be passed on to the consumers in terms of lower prices in the near-term.
As far as the direct tax impact on CPI basket is concerned, GST may not be a significant threat on inflation. For food & beverages (which has a high weight of 46% in the CPI index), prices are expected to come down due to lower GST rates. Housing (weight of 10%, includes rental on residential property) are exempted from the GST rate. Hence, there will be no impact of GST. The miscellaneous category in the CPI (28% weight) mainly covers services like health, education, transportation, etc. For most services, as discussed earlier, the tax rate is increasing from 15% to 18%. Health continues to be exempted under GST. It is to be noted that while primary and secondary education is exempted, higher private education is not exempted from GST. Overall, tax rates on 40% of items in the CPI basket will remain unchanged. The tax rate will come down for 22% of the items and will go up for only 13% of the items in the CPI basket.
International experience shows varied impact in different countries. In countries such as Australia, Canada, Japan, China and Singapore, there was an increase in inflation post-GST implementation. However, other countries like New Zealand, Greece, Portugal, Thailand, and Vietnam saw inflation reducing with the implementation of GST. However, in the case of New Zealand, inflation increased in the subsequent year of the GST implementation.
Coming back to India, while the CPI basket does not show an adverse impact of GST on inflation, we must not ignore the fact that tax on services, which is a big chunk of our GDP, is increasing. Moreover, a large part of the economy (items like petrol, diesel) are outside the ambit of GST. That may also have an inflation distortionary impact as an offset on these items will not be available under GST. In the short-term, it may not be easy to pass on the reduction in cost due to GST. Overall, we feel GST impact on inflation could be somewhere between neutral to a marginal increase in the short-term. In the medium to long-term, GST should put downward pressure on inflation through efficiency gains, reduction in supply chain rigidities and lower transportation cost.