Will the GST Rates stoke inflation; actually it may not!

The big debate over the GST is whether or not it will stoke inflation. Firstly, let us understand the background to this debate. The unique feature of the GST is that it is a consumption tax unlike excise duty which is producer level tax. Therefore, in case of excise duty, there is a time lag between the time the rates are increased and the actual impact on the end customer. Many times, tough competition in the industry will imply that producers may choose to absorb part of the hike in costs instead of passing it on to the customer. On the contrary, the GST is a consumption impost and hence the impact will be immediately felt on the price of goods and services.

The experience of other countries has been that there is a 1-2% impact on inflation in the first 2 years after the introduction of GST. However, over a longer time frame this impact tends to get neutralized by the seamless availability of credits under the GST as well as greater efficiencies introduced by the GST. The billion dollar question is whether the introduction of GST will lead to a spurt in inflation in India too. There are 3 key reasons due to which the impact on inflation may not be very material. Here is why …

More than 50% of the CPI basket is under 0% GST bracket…

This has been consciously done by the GST Council while deciding on the rates of GST. Most of the basic items of consumption that comprise a chunk of the CPI basket have been kept under the 0% GST bracket. This will ensure that there is no cascading effect on inflation. In addition, most of the items of mass consumption which are a key component of the CPI basket have been restricted to a GST rate of 5%. A combination of these 2 rates will ensure that the CPI basket will not see a major impact as a result of the introduction of GST. Even in case of other components of the CPI basket, the rates of GST will be either at 12%, 18% or 28%. That will effectively mean that the status quo will be maintained in case of most of the products.

Will service tax rates impact the inflation level?

Services tax rate continues to be the moot issue as far as inflation is concerned. Services are currently taxed at 14%. In addition, there is a levy of 0.5% on account of Swacch Bharat Cess and an additional levy of 0.5% on account of Krishi Kalyan Cess. This takes the total service tax levy to 15%. Under the new GST regime, the rate of tax on services will go up to 18%. This 3% additional service tax will apply to a variety of services like insurance services, mobile services, broking services, consultancy services, transport services etc. Services have an overall weightage of 30% in the CPI and hence the 3% higher tax will surely impact the inflation level. However, due to seamless availability of cross credits, it is estimated that actual impact of tax on services will be much lower than 18%. While the fine print of the list of services is awaited, the moral of the story is that the impact may not too worrisome.

GST will reduce the cascading effect of taxes in the economy…

This point needs to be understood a little more intricately. What exactly is the cascading effect? In the current indirect tax system, there is absence of free flow of credits between central taxes and state taxes. This creates a cascading effect. The actual impact of indirect taxes is much higher than what it should be. Under the GST regime, irrespective of the rate of taxes, the availability of state and central tax credits will be seamless. Let us understand this with an example. Currently, if you pay state VAT or CST on goods purchased to render services, then the credit for such VAT / CST is not available to the service. This increases the cost of providing the service. Under the GST regime, all such inefficiencies tend to be automatically eliminated. In fact, this can go a long way in bringing down inflation sharply.

In a nutshell, the only real risk to inflation will come from services. However, the salutary effect of a cheaper CPI basket and seamless credits will actually bring down inflation. The impact on inflation may be there in the initial months. But, it looks like the impact may not large enough for the RBI to really worry about!

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