The GST is expected to be implemented from April 1, 2017. Many are worried about its inflationary impact.
There is talk of a revenue neutral rate (RNR) of between 15 per cent to 18 per cent — the rate at which the amount of tax collected under the GST would be the same as that collected at present. A shortfall in revenue is a worry for states, since they cannot easily resort to a deficit budget. For them, the loss of revenue usually translates into cuts in the allocations to welfare programmes.
A single RNR rate implies that some current rates of indirect taxes will rise while some others will fall. For instance, services are taxed at a rate of 15 per cent currently but if the RNR is fixed at 18 per cent, then all services prices will rise. However, if some good faces a combined excise and sales tax rate of 22 per cent then its rate of tax would fall and so would its price. Thus, in the aggregate, prices should not rise with the RNR. But there is a catch: Even with the RNR, the rate of inflation is likely to rise.
Indirect taxes “cascade” from one tax to the other and also feed from one good or service to another. Even though wheat does not bear an excise or a sales tax, when taxes on diesel are increased transport costs rise and so do the prices of wheat. The more basic a commodity, the more the prices of other goods rise. VAT is supposed to get rid of such cascading effects. Sales, excise and service taxes were already collected as VAT. But the cascading of service tax on sales or excise or of sales tax on services and excise, and other such combinations, did not get eliminated and GST is expected to do that. The cascading effect of taxes makes the effective rate of tax higher than in the statute books; so the price rise is also more. Thus, if the cascading effect is removed/reduced, then to collect the same amount of taxes as earlier, the rate of tax under GST must rise. But under a one tax (or a few taxes) regime that would mean higher taxes on basics and, therefore a greater inflationary impact.
If inflation kicks up, inequalities rise, output stagnates and that impacts employment generation. It has also been argued that a single market will hit the small and the cottage sectors even if they are kept outside the GST net. The way out of this political quicksand would be to go for a rate lower than RNR. GST would apply to non-agriculture which is 86 per cent of the GDP. Indirect taxes collected presently are about 10 per cent of GDP. Making allowances for exemptions, expansion of base, bringing black economy into the net, etc. a rate of between 10 per cent and 12 per cent may work. However, the government may need to keep the rate of GST below the currently suggested RNR.