Five-year review of TPS

The results show that it reduced food inflation and increased non-food inflation

The results show that it reduced food inflation and increased non-food inflation

The monumental reform of indirect taxation, the goods and services tax (GST), has completed five years of existence. Before the implementation, it was said that it would be a boon for the economy in terms of buoyant incomes, lower inflation, higher incomes, higher growth, etc. At the end of the five years of GST, it makes sense to wonder what happened to inflation.

In the 12 months prior to the implementation of the GST, consumer price index (CPI) inflation was 3.66%, while it increased to 4.24% after the GST over the next 12 months. However, India is not alone in experiencing rising inflation. A similar trend has been observed in Australia, New Zealand and Canada. A study by the Australian Competition and Consumer Commission showed that the GST initially increases inflation.

Based on the actual inflation figures, it can be concluded that the GST has had an inflationary impact on India. But this is not the right approach to understand whether GST has increased inflation in India. Before systematically looking at this issue, let’s understand how the GST can affect prices.

Understand the mechanism

In theory, the implementation of the GST should not lead to a change in headline inflation. The tax neutral rate (RNR) is calculated in such a way that it does not lead to higher inflation. But revenue neutrality does not mean that prices will not rise or fall in the economy. Indeed, the weight of goods in the consumer basket and their contributions to indirect tax revenue are not the same. For example, food and beverages (which make up 46% of the CPI index), rent, and clothing are all important items in the CPI basket that are either untaxed or taxed at low rates. It is important to note that the effect of GST on the prices of certain goods and services depends on the structure and design of taxation, such as the level of exemptions, the structure of GST rates, the weight of goods and services in the CPI basket, the tax base, the efficiency of the administrative apparatus, etc.

The RBI, in a 2017 report, showed that about half of the groups of items covered by the GST are not in the CPI basket. This study revealed that headline inflation could rise by only ten basis points. Thus, the effect of the GST on prices was expected to be small. Finally, before the implementation of the GST, prices were expected to fall because the GST harmonizes indirect tax rates and eliminates the cascading effect. Thus, the effect of the GST depends on how different factors influence each other.

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So how can we determine if the GST has had an inflationary impact in India? To answer this, we turn to statistical modeling, which will give us a precise and clear-cut estimate of the causal impact of an intervention. In a nutshell, this model uses pre-intervention data (before July 2017) to train the data to estimate counterfactual inflation estimates. A counterfactual estimate is nothing more than an estimate of inflation if the intervention (in this case, the GST) had not taken place. The causal estimate would then be the difference between the true and counterfactual trends. The outcome variable chosen is retail price inflation (CPI).

Our statistical results give us an interesting picture of the impact of the GST on the price level. First, we look at the overall price index (CPI). Here, the actual CPI growth over the study period is 4.61%, while the counterfactual inflation estimate is 3.24%. This implies that without the implementation of the GST, CPI inflation would have been 3.24%. This indicates that with the implementation of the GST, the CPI increased by 1.37 percentage points (pp). Second, we also find that core CPI inflation (which excludes volatile components such as food and fuel from headline inflation) increased by 1.04 pp in the post-GST period. (actual inflation was 4.57%, counterfactual inflation was 3.53%).

Third, the GST has a significant positive impact on the inflation of product groups such as paan, tobacco and intoxicants, clothing and footwear, housing and various sectors (consisting mainly of services). In the case of non-exempt food and beverages, the implementation of the GST has a negative impact of 4.42% on the price level.

Rise in inflation after GST

The rise in inflation after the implementation of the GST could be due to the increase in the tax rate of certain goods and services, the inclusion of business activities that were not previously taxed or the structure of the market. The weighted average GST rate was designed to be neutral, so it may not have contributed much to the higher inflation observed. Covering commercial activities with the previously untaxed GST would result in higher prices as businesses would pass the cost on to consumers. Although the informal sector suffered following the implementation of the GST, many businesses jumped the tax net to take advantage of the input tax credit and escape the punitive reverse charge mechanism.

There is another possibility that would result in earnings inflation after the implementation of the GST. Textbook microeconomics teaches us that market competition leads to lower prices. And when market power increases, prices rise and profit follows. As Nobel Prize-winning economist Joseph Stiglitz has said, increasing market power is bad for the economy because it increases economic inefficiency and inequality and reduces the resilience of the economy. Also, taking advantage of market power, it is possible that most businesses passed on the taxes to end consumers, which would have led to an inflationary push in GST costs.

Our statistical exercises provide conclusive evidence that the implementation of the GST had an inflationary impact on the Indian economy. Note that the prices of petroleum products increased significantly, which may have contributed to the rise in the CPI after the introduction of the GST.

To sum up, our statistical results suggest that the implementation of the GST resulted in a decrease in food inflation and an increase in non-food inflation such as CPI, paan, tobacco and intoxicants, clothing and footwear, accommodation, miscellaneous and not exempt. food and drinks.

Our analysis suggests that prior to the implementation of the GST, market concentration as measured by various indicators was increasing, suggesting an oligopolistic market structure. This determines whether or not the GST benefits are passed on to consumers. However, with the existence of market power, the price of firms includes a large margin over marginal costs. Our results highlight the possibility of profit in some segments after the GST. To anticipate this possibility, the government has set up the National Anti-Profit Authority (NAA) to ensure that companies do not use the GST as an excuse to raise prices.

Our findings suggest that the NAA should monitor the prices of critical or essential goods and services to see the impact of GST on prices. Similarly, the Competition Commission of India should observe anti-competitive behavior by producers that harms consumers through excessive price increases. These measures can result in producers not benefiting from the GST.

Santosh Kumar Dash and Anoop S. Kumar are Assistant Professors of Economics at Gulati Institute of Finance and Taxation, Thiruvananthapuram. Views are personal

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