GST law should ensure benefits of lower prices are passed on to common people

Many have heralded the introduction of the GST as the single most important reform that has been initiated in the arena of indirect tax system in India. The main objective of GST is to simplify the indirect tax structure and unify taxation. That, in turn, is expected to bring about several positive impacts such as increasing the ease of doing business, increasing compliance, raising the GDP growth rate by 1-2 percent, lowering inflation and increasing government tax revenue. The obvious question that arises is whether these claims hold any water and under what circumstances these expectations are likely to be fulfilled with the introduction of the GST.

GST law should ensure benefits of lower prices are passed on to common people


What exactly does the GST bring to the table?

The Indian indirect tax structure at present comprises an array of taxes - those that are levied by the Centre such as central excise duties, CENVAT (Central Value Added Tax), central sales tax, Countervailing Customs Duty, service tax, etc., and those levied by States like State VAT/sales tax, octroi or entry tax, etc.

Since a number of these taxes do not fall under the purview of Value Added Tax (VAT), a tax levied only on the ‘value added’ at each of stage of a supply chain (and not on the entire value of sales or of production), the indirect tax system continues to be plagued by the problem of “cascading effect of taxes”.

This cascading effect, whereby an item is taxed several times from the production to the final retail sales stage, has the effect of raising the tax component of products and leads to higher tax-induced prices. Further, multiple taxes imposed by different States and the Central Government give enormous scope for tax evasion. The GST would put an end to this system as the complex web of multifarious indirect taxes that exist at present would be replaced by one indirect tax: the GST.

The GST, though a single tax, would comprise two components: a central GST and a State GST. As per the Committee headed by A. Subramanian, the number of rates is likely to be limited to: i) a standard rate to be levied on majority of goods and services, ii) a lower rate on merit goods and essential items, and iii) a higher rate on non-merit goods like luxury goods.

Benefits of GST

Uniform rates of taxation on goods and services (barring the non-GST items such as petroleum, tobacco, alcohol, etc.), would help to simplify and rationalise the tax system and increase compliance. Uniformity of taxation, it is argued, would also remove barriers in the movement of goods across the country arising out of the differing rates at different locations. Further, since the GST is a form of VAT, by “giving input credit for taxes paid on inputs at every stage of the supply chain and taxing only the final consumer, it avoids the ‘cascading’ of taxes”, thereby reducing the tax component of a product.

Taking a closer look at some of its purported macro impacts

All these factors, the arguments go, would have several positive impacts on the economy. While it is possible that the removal of a plethora of taxes does help the big businesses, there is a need to tread carefully in conjecturing several other positive impacts the GST is supposed to have.

The explanatory chain that underlies the argument that the GST would raise economic growth is that savings in cost arising out of either lower tax component (owing to crediting of input taxes) or efficiency gains/economies of scale, would reduce prices of goods, thereby increasing demand for various goods and hence growth. The critical assumption here is that there will be a full or nearly full pass-through of cost reduction (if any) into the prices.

Empirical research, however, shows that while an increase in indirect taxes is generally passed through fully into consumer prices, lower indirect tax rates do not necessarily result in reduced prices. So unless, there is a near full pass-through of lower taxes into consumer prices, the GST by itself might not translate into a higher rate of growth. In fact, experience of some of the countries, which have a similar GST system in place, shows that there is no positive relationship between introduction of a GST system and economic growth.

Likewise the argument that inflation would come down over the years is based on similar assumptions mentioned above. Even the argument that there would be mild inflation that too only in the initial phase, is problematic because nobody yet knows what the rates of taxation would be. If the standard rate is high or the tax rate on essential commodities is significantly higher than existing rates, it could have significant impact on inflation.

Besides, since now services, which did not have to pay State sales tax earlier, would have to pay the standard tax rate calculated with the inclusion of other taxes, these will end up being more expensive. Lastly, there is always the possibility that taxes may be hiked in the future since only experience would make it clear what rate of taxes would ensure “revenue-neutrality” or that the amount of revenue raised remains same as before. If a revenue shortfall is tried to be compensated for by raising GST tax rates or taxes on petro products (which do not fall within the GST at present) the inflationary effects would be large.

To address these problems, the government can perhaps think of introducing a clause in the GST law to ensure that there is a pass-through of the benefits derived from GST on to the common people in the form of lower prices. Further, in case of a revenue shortfall, instead of relying on increasing taxes on petroleum products, the Centre could even think of relaxing its deficit target, as the A. Subramanian Committee suggested.

Malini Chakravarty is with Centre for Budget and Governance Accountability (CBGA). The views expressed are personal.

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Updated Date: Aug 23, 2016 18:10:29 IST

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