It’s been over three weeks since the goods and services tax has been reduced for a vast number of items. The reduction in rates has been timed well to light up the ongoing festival season.
On cue, companies across sectors have announced a reduction in the prices of goods, though some have run into logistical humps reaching consumers at new prices. This would mean prices will come down for items that have seen a GST rate cut but for some the transmission could take slightly longer than others.
Leading automakers reported a sharp rise in both bookings and sales alongside steep price cuts tied with the new GST regime.
So far, the Reserve Bank of India’s latest consumer confidence surveys have shown only a moderate improvement in both urban and rural areas, but sentiments are expected to edge up in the coming months as the GST-led price cuts become broad based.
GST rate cuts was one of the key reasons why the monetary policy committee of the RBI, during its October review meeting, raised its forecast for India’s GDP growth (6.8% from 6.5%) and lowered its average retail inflation call (2.6% from 3.1%) for this fiscal.
The rationalisation of GST rates offers multiple benefits, such as nudging consumption, subduing retail inflation and improving tax compliance.
Yet these objectives may be met at different speeds, as they depend on a wider set of macroeconomic factors. We explore them here:
Consumption Boost
We find, basis the household consumer expenditure surveys, that the new GST rates will benefit 11 of the top 30 consumption items, accounting for a third of the monthly expenditure of an average consumer.
These 11 items include essentials (such as milk products), discretionary products (such as automobiles and beauty services) and goods that are seeing a surge in demand over the past few years (such as processed food).
But the levy remains unchanged for many major consumption items, such as mobile phones and restaurant services. Based on the top 30 items, the simple average GST rate has reduced 200 basis points to 9% under the new regime.
The middle class stands to gain more, as many items, such as clothing, footwear and hotel services have seen rate reductions on only lower-value items.
The premium variants of clothing and footwear have seen a tax hike, possibly with the objective to offset some revenue loss for the government.
The final impact on consumption will depend on a broader set of factors—primarily, the speed with which producers pass the rate cuts to consumers across all categories.
One hurdle to an immediate lowering of prices is the overhang of costlier inventory.
But from an inflation perspective, lower taxes will have a one-off effect on retail prices, either spurring consumption or uptrading. Similarly, the inflation impact will depend on the speed of passthrough to consumers.
The proclivity of consumers to spend is also a function of how they view their economic situation and income prospects.
Better Compliance
The primary motivation for GST rationalisation has been the simplification of the rate structure to ease compliance and deliver a stronger push to formalisation.
For instance, the GST council has tried to address the issue of inverted duty structure to some extent, where the rate of tax on inputs exceeds that on the output. The IDS has been corrected on manmade textiles and fertiliser sectors. Further, a broad-based procedural relief for refunds has been announced whereby businesses will be able to receive faster refunds of their accumulated input credits. This will mean easier cash flow management.
That said, resolving the IDS issue remains a work in progress.
The government also launched the GST Appellate Tribunal, which promises to offer a specialised, uniform and more efficient mechanism for resolving GST disputes, ultimately leading to improvement in the ease of doing business. The GSTAT is expected to commence hearing before year-end.
Other process reforms have also been announced to facilitate trade. For instance, applicants will be granted automatic GST registration within three working days subject to certain conditions.
Lessons From Abroad
Global evidence confirms that passthrough of tax changes varies significantly across countries and is influenced by several factors, which include duration of the rate cuts (permanent or temporary), timing of the cut (during stable periods or economic shocks), and the presence of complementary policies (such as income support measures).
Governments across the world have altered consumption-related, or value-added-tax rates, but for varying purposes.
France (during the 2008 Global Financial Crisis) and Germany (during the 2020 Covid-19 pandemic) used temporary VAT cuts to boost consumption as the fog of recession descended.
Japan has hiked consumption taxes over the past three decades to support government revenue.
Research on such episodes of consumption tax changes highlight the importance of passthrough in the impact on consumption.
A 2008 study in France (Benzarti and Carloni, 2017) showed the cut in the value-added tax had a limited impact on consumption since producers retained a chunk of the benefit.
On the other hand, a 2020 study in Germany (Bachman, et al., 2021) showed VAT cuts were effective when complemented with income transfers.
Tax changes typically are also observed as having a more pronounced effect on consumer durables than non-durables.
Three Aspects Of Change
Over time, we see the impact of rationalisation percolating in three ways:
For households, the reduced incidence of GST on essentials frees up disposable incomes and should nudge up consumption.
For businesses, the simpler slabs and easier compliance should improve operational efficiencies.
For the government, though there is an expectation of revenue loss in the short term, over time improved buoyancy from incremental consumption and the higher-rate GST categories can continue to yield a steady stream of income.
Stoking domestic demand amid lingering global uncertainties is apposite. With a 50% US tariff hike in force since August-end, exports are expected to face more pressure in the second half of this fiscal.
The hope is that GST rate rationalization should have a positive bearing on the consumption demand, which in turn provides support to the private capex cycle in the economy. The government has shared estimates on revenue impact (net loss of an annualized Rs 48000 crores), which by itself does not entail concerns on fiscal slippage. But weaker tax collections due to slower nominal GDP growth, could put pressure on revenue collections this fiscal.
Dipti Deshpande is a principal economist; and Adhish Verma and Pankhuri Tandon are senior economists at Crisil Ltd.
Disclaimer: The views expressed here are those of the authors and do not necessarily represent the views of NDTV Profit or its editorial team.
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