30 August 2016 13:15:22 IST

Will GST stoke inflation?

Experience of a few nations show that GST implementation has driven prices higher for a year

GST — the Goods and Services Tax — which was debated and discussed for 13 long years, has finally got a green flag from both houses of Parliament. The Finance Ministry has indicated that after State legislatures (at least 50 per cent of them) ratify it, the tax will be rolled out and will have two components — Central GST and State GST.

Once this tax comes into effect, it will subsume all the indirect taxes in goods and services (with some exceptions), and establish a uniform tax rate across States. Under it, only the value addition at each stage will be taxed, and credit for input taxes will be available to the producer or the seller. If these benefits are passed on, the end consumer will see some savings.

However, experts warn that the new tax may be inflationary in the initial years.

How much inflation?

The eventual impact of GST on prices of goods and services is dependant on the rate of tax, which is yet to be finalised. However, experience of a few nations like Australia, New Zealand and Canada show that GST implementation has driven prices higher for a year.

A report by the GST committee headed by Arvind Subramanian, Chief Economic Adviser, released in December 2015, gives some indications.

It says that in a dual rate scenario, with a lower rate of 12 per cent and a standard rate of 18 per cent (which works out to a revenue neutral rate of 15-15.5 per cent), there will be a negligible inflation impact. Alternatively, with a lower rate of 12 per cent and a standard rate of 22 per cent, there would be a 30-70 basis points impact on aggregate inflation.

Items of mass consumption, food and fuel, that will affect the poor, if exempted, will see minimal impact, it adds. However, in case of a single rate, higher the rate, the higher will be the impact on inflation. If it is 14 per cent for instance, it would drive prices higher by 0.7 per cent (assuming producers factor in input tax credit).

An 18 per cent single rate would increase prices by 2.5 per cent with or without input tax credits. The items that will bear the brunt are clothing and medicines (and food, education costs to an extent), says the report. Services inflation is also likely to shoot up. Even if the final tax rate (as has to be decided by the GST Council) is around the standard 18 per cent as recommended by the GST Committee, services will get dearer for the common man.

The cost of legal, accounting and auditing services, banking and financial, insurance, transportation and logistics, dry cleaning, gym or salon services, will get expensive as these get taxed at only 15 per cent (including cess) now.

The Centre wants to keep the new tax rate revenue neutral (called RNR — a rate which would yield the same revenue as collected from various taxes at present), but, how successful it will be in doing that has to be seen.

Currently, about 54 per cent of the items of the CPI basket are exempt from excise and sales tax; in addition, 32 per cent of it is taxed at a lower rate. So, if the present exemptions continue, the impact on overall inflation may be negligible.


There have been several suggestions made to the Centre to counter the impact on prices post GST. A mechanism to check if producers and sellers pass on the benefit from the reduced tax flows (at least in sensitive items) has to be put in place.

The Competition Commission of India may be given the task of keeping anti-competitive producer behaviour under check. The other suggestion is that the Centre should consider taxing essential services at a lower than the standard rate, and tax demerit goods (such as alcohol and tobacco) at higher rates.