Much of the discussion on the potential impact of the goods and services tax (GST) on inflation has tended to focus on the rise in headline Consumer Price Index (CPI). But, as the increase in tax rates will vary across product categories, the actual impact on the end-consumer will depend on the composition of his consumption basket.
Assuming the revenue neutral rate (RNR) works to be around 17-18 per cent, a standard rate of 22 per cent, with a lower rate of 12 per cent for some items and a higher rate of 35 per cent for others, the sharpest tax increases are expected in categories such as health, clothing and footwear, medicines and electricity, according to the report on RNR, prepared by the Chief Economic Advisor (CEA).
Taxes on health, excluding medicines, could rise from 8.8 per cent currently, to around 13.6 per cent – an increase of 4.8 per cent. Those on clothing and footwear would rise to 13.8 per cent, up from 9.5 per cent currently, while those on medicines and electricity would rise by 1.2 and 1.1 per cent, respectively. Other items in the CPI basket are likely to witness lower tax hikes, with the exception of oil and fat, which would actually see a decline of 0.6 per cent. But this is just an indicative rise. The actual rise may well be of a higher magnitude, depending on the final tax rates that the GST committee finally decides.
But the impact of this increase in taxes on household expenditure depends on how much they are currently spending on these categories. Data presented in the CEA’s report show that, on average, the bottom 40 per cent of the population, who constitute the poor, spend roughly 7.1 per cent of their consumption expenditure on clothing. By comparison, the rest of the population spends 5.4 per cent. This implies that any increase in taxes on clothing is likely to hit the poor to a relatively large extent.
Data also show that while the poor spend only one per cent of their total expenditure on health, including medicines, this rises up to 5.5 per cent of total household expenditure. By comparison, the rest of the population spends roughly 7.5 per cent on health and medicines. Thus, both segments are likely to be equally hit by any rise in taxes on health services, including medicines.
On the flip side, cereals, fuel and light, which account for a fourth of the expenditure of the poor, are only likely to see a marginal increase in taxes.
“Ultimately, the higher government revenue would be a cost borne by some sections of consumers. This may have an impact on households’ inflationary expectations, even if inflation indices do not register a rise, based on their static composition,” Icra noted.
Currently, 49 per cent of items in the CPI are taxed at zero rates. Another 32 per cent attract low tax rates, ranging between 0-12.4 per cent. Fifteen per cent are taxed at normal rates, ranging between 12.4 to 29.4 per cent, while another four per cent are taxed at higher rates.
The poor are likely to suffer on account of taxes on education too. “Education taxes also turn out to be regressive, as consumption of books and school supplies is a higher part of education spend for the bottom 40 per cent, and tuition (mostly tax-exempt) is a higher spend for the top 60 per cent,” noted the CEA’s report.
Though the report also shows that an 18 per cent standard rate would reduce CPI by 0.1 per cent, going by news reports, the final rate is likely to be much higher.
“A revenue neutral rate may not necessarily be inflation neutral, given the different contribution of goods and services to the tax kitty, compared to their weights in the inflation indices such as CPI and Wholesale Price Index (WPI). For instance, tax incidence on services is likely to go up under the GST regime; however, WPI does not include services, and their weight in the CPI is limited,” says Icra.
While most analysts expect inflation to rise in the short term, CARE expects CPI to increase by 20-30 basis points. There is a way for the government to moderate the rise in inflation, with the implementation of GST, as the example of Malaysia shows.
Malaysia implemented GST in 2015, with a higher tax rate of six per cent, against earlier three per cent. But, as Nomura points out, inflation moderated sharply. This occurred largely due to the pass-through of lower oil prices.
If inflation does head upwards, close to or exceeds Reserve Bank of India’s target of six per cent, the government could simply reduce the additional taxes that it has levied on petrol and diesel, in the wake of falling crude oil prices. This would immediately bring down prices of fuel and have a moderating effect throughout the supply chain.
