impact-of-gst-on-inflation

Why in the news?

The indirect tax reform, the Goods and Services Tax (GST), completed its five years in existence.

How GST can affect prices

  • In principle, implementing GST should not guide to a change in overall inflation.
  • The revenue-neutral rate (RNR) is calculated so that it would not originate higher inflation.
    • A revenue-neutral rate(RNR) is a structure of different rates established to match the current revenue generation with revenue under the GST
  • But revenue neutrality does not signify that prices would not hike or reduce in the economy.
  • Essentially, the effect of GST on the prices of certain goods and services pivots on the structure and design of taxation.
  • In a 2017 report, RBI displayed that about half of the groups of items that GST covers are not in the CPI basket.
  • So, the effect of GST on values was expected to be minimal.
  • Ultimately, pre-implementation of GST, it was expected that prices would reduce because GST balances indirect tax rates and discards the flowing effect.
  • Therefore if GST has any effect wholly depends on how different attributes affect each other.

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

  • The inflationary effect can be evaluated by examining statistical modelling.
    • Statistical results provide us with an interesting idea of the impact of GST on price levels.
  • First, we check the overall price index (CPI).
  • The actual CPI growth in the study period is 4.61%, but the relative estimate of inflation is 3.24%.
  • This implicit that without the GST implementation, the CPI inflation would have been 3.24%.
  • This signifies, that with the implementation of GST, CPI increased by 1.37%.
  • CPI core inflation (which strips off volatile components such as food and fuel from the headline inflation) increased by 1.04% in the post-GST period (actual inflation was 4.57%, relative inflation was 3.53%).
  • GST is found to have a notable positive effect on the inflation of products such as paan, tobacco, and intoxicants.
    • These items have around 20% weightage in the CPI basket and could see a one-time transitory inflation hump.

What explains the rise in inflation post GST?

  • Hike in the tax rate of some goods: The rise in inflation after GST implementation could be because of rising in the tax rate of some goods and services.
  • The average weighted GST rate was manifested to be neutral, so it might not have subscribed much to the observed higher inflation.
  • Coverage of business activities under GST not taxed earlier would result in high prices since the companies would pass on the cost to the consumers.
  • Market power: There is a probability that would cause result inflation after the GST implementation.
  • As Joseph Stiglitz stated, increasing market power is not good for the economy as it raises economic inefficiency and inequality and lowers the economy’s resilience.
  • Further, taking benefits of market power, it is feasible that most firms would have passed the taxes to end consumers.
  • With the existence of market power, companies' price includes a notable mark-up over minute costs.
  • Some results show the chances of profiteering in the select divisions after GST.
  • To prevent this prospect, the government set up the National Anti-profiteering Authority (NAA).

Criticism of GST

  • Before the implementation, it was stated that it would be a boon to the economy in terms of higher revenue growth, lower inflation, higher revenue, higher growth etc.
  • During the 12 months foregoing 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 related pattern was observed in Australia, New Zealand, and Canada.
  • An Australian Competition and Consumer Commission examined and showed that GST at the beginning increased inflation.

Way forward

  • NAA should regulate the prices of major or essential goods and services to see the price effect of GST.
  • Alike, the Competition Commission of India should note anti-competitive producer behaviour that wounds consumers via large price increases.
  • These steps may secure producers from not taking advantage of the GST.

Conclusion

  • Statistical results advise that GST implementation has resulted in a reduction in inflation of food items and hiked inflation of non-food items.