Will it help cut prices?

It will improve corporate earnings, attract investment, generate employment and boost the economy. Sounds like a pitch by an over-enthusiastic salesman, right? But there really is a whole lot riding on the Goods and Services Tax (GST), which is to be introduced in 2010. Economists and tax experts see it as the biggest tax reform in independent India. But what does it mean for you?

The GST will replace most other indirect taxes (see table) and harmonise the differential tax rates on manufactured goods and services. Right now, the effective tax rate on manufactured goods works out to 20%, while services are taxed at 10.3%. The GST rate has not been decided yet, but it is likely to be around 15%. So, the tax on manufactured goods could go down while that on services could go up.

This doesn’t mean that the GST is a zero-sum game for consumers. The real benefits for them could come from the way it reduces the tax burden on corporates. Right now, businesses pay taxes levied by the Centre and states at every stage of the supply chain. This cascading effect of taxes pushes up the costs of products and services, which the consumer has to bear.

Under the GST, businesses will be allowed to set off the taxes they pay when they purchase any raw material, good or service (see graphic). In the example, all players in the supply chain pay 15% GST on the value addition done by them. The consumer also pays only 15% tax on the price of the product. “The strength of the GST lies in avoiding the continuous levying of taxes from producer to consumer,” says West Bengal Finance Minister Asim Dasgupta, who heads the panel of state finance ministers set up to give final shape to the GST.

The setting off provision of the GST has far-reaching implications for businesses. If they are refunded the taxes paid on inputs, service providers, producers and distributors will see a significant dip in costs. Also, the supply chain structures will become more efficient. Consumers stand to gain if these cost benefits for producers translate into lower prices. For instance, companies may no longer have to set up depots in every state to avoid tax. Instead, one large depot can service three-four states.

This should be great news for India Inc. It is estimated that a 2% reduction in costs can increase a company’s profits by more than 20%. The Centre and state governments also stand to benefit. While the tax rate itself is unlikely to increase revenues, the broadening of tax base and greater compliance could boost collections. The GST structure and the provision for setting off taxes on inputs will nudge many businesses into the tax net. “Even if one link in a supply chain insists on an invoice, the entire chain will have to come into the tax net,” says R. Muralidharan, executive director, Pricewaterhouse-Coopers. According to a study by the National Council of Applied Economic Research, the GST can boost India’s GDP growth by 2-2.5%.

However, the gains for the aam aadmi are still wrapped in conjecture. It’s not clear if the benefits will be passed on to the consumer. When Australia introduced the GST in 2000, the government had set up a commission to protect the interests of consumers. The commission monitored prices to ensure that consumers got full benefits from the reduction in tax rates. If the tax rate went up, it ensured that consumers were not charged more than what was necessary. It could levy fines of up to $10 million on businesses if they resorted to excessive profiteering.

The ACCC had also launched a nationwide consumer awareness campaign on how GST would affect prices. The Everyday Shopping Guide with the GST provided a range of expected price movements for 185 household goods and services and was widely distributed.

Indian lawmakers, however, do not think it important to discuss the impact on the consumer. The issue of price control did not figure in the discussions of the empowered committee of state finance ministers. “Price control was not discussed, but the GST will generate employment and boost growth. The common man will also gain from this,” says Manpreet Singh Badal, the finance minister of Punjab.

While state intervention in pricing might seem regressive, experts agree that consumer interests need to be protected. “Limited state intervention and effective administration in pricing will bring certainty and confidence to the market and the consumers,” says Sunil Tyagi, partner in law firm Zeus Law Associates. Other feel that Adam Smith’s invisible hand will come to the rescue of the consumer. “State intervention may not be necessary because if a company overcharges, market forces will bring the prices down,” says Prashant Deshpande, senior director, Deloitte India.

The GST is way behind schedule. On 10 November, the empowered committee submitted the first discussion paper on the new tax and invited comments from various sections. We hope that when the panel meets again, the impact of the GST on consumer prices will be discussed and a mechanism to ensure fair pricing will be formulated.