Goods and Services Tax (GST)

Impact of GST on inflation

Note4Students

From UPSC perspective, the following things are important :

Prelims level : National Anti-profiteering Authority

Mains level : Paper 3- Impact of GST on inflation

Context

The monumental indirect tax reform, the Goods and Services Tax (GST), has completed five years in existence. The article analyses the impact of GST on inflation.

Background

  • Before the implementation, it was said that it would be a boon to the economy in terms of higher revenue buoyancy, lower inflation, higher revenue, higher growth etc.
  • During the 12 months preceding GST implementation, the Consumer Price Index (CPI) inflation was 3.66%, while it increased to 4.24% post-GST in the next 12 months.
  •  A similar pattern was observed in Australia, New Zealand, and Canada.
  • An Australian Competition and Consumer Commission study showed that GST initially increases inflation.

How GST can affect prices

  • In theory, implementing GST should not lead to a change in overall inflation.
  • The revenue-neutral rate (RNR) is calculated so that it would not cause higher inflation.
  • But revenue neutrality does not mean that prices would not go up or down in the economy.
  • This is because the weight of goods in the consumption basket and their contributions to indirect tax collections are not the same.
  • Importantly, the effect of GST on the prices of certain goods and services depends on the structure and design of taxation.
  • The RBI, in a 2017 report, showed that about half of the groups of items that GST covers are not in the CPI basket.
  • So, the effect of GST on prices was expected to be small.
  • Finally, prior to the GST implementation, it was expected that prices would go down because GST harmonises indirect tax rates and eliminates the cascading effect.
  • Thus, whether GST has any effect depends on how different factors affect each other.

So, how can we ascertain whether GST has had an inflationary impact in India?

  • Inflationary impact can be assessed by turning to statistical modeling?
  • Statistical results provide us with an interesting picture of the impact of GST on price levels.
  • First, we look into the overall price index (CPI).
  • Here, the actual CPI growth in the study period is 4.61%, whereas the counterfactual estimate of inflation is 3.24%.
  • This implies that without the GST implementation, the CPI inflation would have been 3.24%.
  • This indicates that with the implementation of GST, CPI increased by 1.37 percentage points (pp).
  • Second,  CPI core inflation (which strips off volatile components such as food and fuel from the headline inflation) increased by 1.04pp in the post-GST period (actual inflation was 4.57%, counterfactual inflation was 3.53%).
  • Third, GST is found to have a significant positive impact on inflation of commodity groups such as paan, tobacco and intoxicants, clothing.

What explains rise in inflation post GST?

  • Rise in tax rate of some goods: The rise in inflation post-GST implementation could be due to the rise in the tax rate of some goods and services, the inclusion of business activities that were not taxed earlier, or the market structure.
  • The average weighted GST rate was designed to be neutral, so it might not have contributed much to the observed higher inflation.
  • Coverage of business activities under GST not taxed earlier would result in higher prices since the firms would pass on the cost to the consumers.
  • Market power: There is another possibility which would cause result inflation after the GST implementation.
  • As Joseph Stiglitz opined, rising market power is bad for the economy as it raises economic inefficiency and inequality and lowers the economy’s resiliency.
  • Further, taking advantage of market power, it is possible that most firms would have passed the taxes to end consumers.
  • With the existence of market power, firms’ price includes a significant mark-up over marginal costs.
  • Some results point out the possibility of profiteering in select segments after GST.
  • To pre-empt this possibility, the government set up National Anti-profiteering Authority (NAA).

Way forward

  •  NAA should monitor the prices of critical or essential goods and services to see the price impact of GST.
  • Similarly, the Competition Commission of India should observe anti-competitive producer behaviour that hurts consumers via excessive price increases.
  • These measures may ensure that producers do not take advantage of the GST.

Conclusion

Statistical results suggest that GST implementation has resulted in a decrease in inflation of food items and raised inflation of non-food items.

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