Fitment panel's GST recommendations may cause immediate spike in inflation

The 5% tax rate broadly covers most food items, so an increase here would directly impact the monthly grocery budget of households

The fitment committee consisting of central and state officials, recently recommended increasing the GST rate of five per cent to seven per cent, and the 18 per cent rate to 20 per cent in order to raise additional resources.

The proposal would be discussed by the group of ministers (GoM) headed by Karnataka chief minister Basavaraj Bommai and then taken up by the GST Council. While many were looking at a merger of the 12 per cent and 18 per cent rates to about 15 per cent, the recommendations of the committee were in fact to raise the rates. However, the GoM  is also likely to consider the merger of the rates.

When the GST system was being finalised, a committee headed by then chief economic advisor Arvind Subramanian had come out with a revenue neutral rate (RNR) of 15-15.5 per cent, depending on the rates adopted by the GST Council. He had recommended three rates of two, four and six per cent on precious metals, a 12 per cent rate on goods, and a high rate of 40 per cent on non-GST goods under both options. However, he suggested three standard rates on goods and services: 16.9 per cent, 17.3 per cent and 17.7 per cent. These would give an RNR of 15 per cent. The other three rates recommended were: 18 per cent, 18.4 per cent and 18.9 per cent. These would give an RNR of 15.5 per cent. While an RNR of 15 per cent was preferred, 15.5 per cent was an alternative.

The GST regime currently has four main rates--5 per cent, 12 per cent, 18 per cent and 28 per cent. Besides, it has rates lower than 5 per cent for bullion and additional cess for items such as automobiles and cigarettes, which attract the peak rate of 28 per cent. These rates are equally divided between the Central GST and the State GST. For instance, 12 per cent GST means six per cent CGST and SGST each.

After GST was rolled out on July 1, 2017, the Council has been modifying rates on various goods and services, and has been mostly lowering them. However, the slabs remained at 5, 12, 18 and 28 per cent.

GST collections have been robust and in fact, only two months till November this financial year have yielded less than Rs one trillion in collections. In this regard, many demanded that there should be fewer slabs of GST.

Currently, 282 goods and seven services are taxed at five per cent and 462 goods and services at 18 per cent.

In case the fitment committee's recommendations are accepted by the GoM and then the GST Council, won't it lead to increase in inflation since most of the items attracting five per cent GST are of mass consumption and 18 per cent tax is imposed on the largest number of goods and services?

The Reserve Bank of India's Monetary Policy Committee on Wednesday raised its projections for the retail price inflation to 5.1 per cent for the ongoing third quarter of the current financial year from earlier 4.5 per cent.

Rajat Mohan, senior partner at AMRG and Associates, said increase in the tax rates would contribute to inflationary trends in the country. "The five per cent tax rate broadly covers most food items, especially milk, yogurt, paneer, honey, packaged food products etc. An increase in the tax rate for such things would directly impact the monthly grocery budget of every household in the country," he said.

He said any increase in the present tax rates would also immediately impact the revenue neutral tax rate. "Any significant change in the tax rates pushes the sector in a reset mode whereby the affected sectors would spend months to find an equilibrium price for various commodities," Mohan said.

He said the long-standing demand of merger of 12 per cent and 18 per cent to a revenue-neutral rate would also need a relook in the light of the report of the fitment committee report.

It should be noted that while the raising of the GST rates may increase the inflation rates immediately, its effect after one year may wane because inflation is calculated year-on-year.

M S Mani, partner at Deloitte India, said inflation may be an issue but it is not the biggest one.

"The two per cent increase in GST rates may not raise the inflation rates much for the consumers. This is so because we have been seeing wholesale price inflation anyway without GST rate change. Inflation would not be something that is triggered because there is a GST rate change. GST may contribute a miniscule percentage point to the inflation rate. We are talking of two percentage points and not five or ten percentage points," Manid said.

He said the larger issue is that billions of businesses will have to make changes in their software, accounting system, invoicing system, billing system, computer framework, procurement system etc.

"It will be a system-wide change. So if this is done, all registered businesses should be given sufficient time to prepare. Ideally, at least three months time should be given to businesses to prepare for change in rates," Mani said.

Once change is made effective, the businesses which have given their purchase orders to their vendors will have to revise those, the indirect tax expert at Deloitte said.

"Goods which are in transit on the day of the change, they will also have to be taken into account. Pricing will have to undergo a change. They (businesses) will need at least a quarter to change," he said.  

Abhishek Rastogi, partner at Khaitan & Co., however, said the Indian economy is again at the growth trajectory which is evident from the high GST revenue collected last month. In such a situation when the revenue collection is already at its peak, any tax increase may burden the taxpayer.

GST collections touched Rs 1.31 trillion in November, the second record after April's figure of Rs 1.40 trillion.

He said to augment the revenue and improve tax buoyancy, the pragmatic approach could be to improve the tax compliances and recoveries rather than increasing the tax rate.

"The services getting taxed at 20 per cent will certainly be a high rate and must be avoided at this stage," he said.

Saket Patawari, executive director indirect tax at Nexdigm said," We are already witnessing a surge in price indices due to supply and shipping constraints, rising demands for goods and services as well as higher wages."

Increase in the GST rates would certainly add to the inflation rate especially the services sector which has been on a fast paced path to recovery, he said.

However, rationalization of the GST rate is something that needs to be considered which would mean an increase in the rate for certain categories charged at a lower rate of five per cent or 12 per cent and reduction of the rate of GST for a higher rate of tax of 18 per cent, he said.

Smita Singh, partner at Singh and Associates said today the average rates of GST have significantly come down as compared to pre-GSTperiod due to multiple rate cuts since July, 2017.

"However, in the backdrop of the pandemic where the industry and consumers are getting back to normalcy, an increase in rate will cause a lot of distress in various sectors," she said.

While the categories of goods and services where rates are to be increased have not yet been decided, any increase in the rate in the fast moving consumer goods sector, branded goods, consumer goods will cause distress both to the manufacturer and ultimately the consumer who will bear the brunt of consequent increase in prices, she said.

"A mere increase in tax rate without combining the tax slabs would definitely have an inflationary impact and will cause burden on the ultimate consumer since the effect of rate increase will be passed on to them," Singh said.