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GST no panacea

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The Goods and Services Tax (GST) is being flaunted as the single-biggest economic reform since the economic liberalisation of 1991. Even critics of the tax, who complain about its complex four-slab rate structure, agree that it is a step in the right direction. The primary reason is that it does away with the present system of multiple Central and State taxes, replacing it with a much simpler tax system.


Another supposed benefit of GST is that it is a tax on consumption, which replaces the current web of ‘cascading’ taxes in the production chain that increases prices and distorts production. In the process, it is said, the new tax system does away with the barriers to free trade within and between States, effectively turning India into a single free market for goods and services.

For sceptics, there is good reason to doubt all these claimed benefits of the GST. One, a nationwide tax such as the GST will lead to a higher tax burden as it reduces tax competition. Earlier, States which were keen to attract investment and labour from each other had a reason to cut taxes. Now, the Centre, which will face no tax competition except from the rest of the world, can determine rates at whim. This will encourage tax rate increases that are detrimental to growth.

Two, the number of taxes does not necessarily reflect the actual burden imposed on businesses by any tax system. For example, a single, high tax rate might impose a greater burden on businesses than multiple taxes that add up to a lower rate.

A single, low tax rate might also turn out to be more burdensome if the cost of bureaucratic compliance is higher than under multiple, higher tax rates. So what matters eventually is the overall burden under a tax regime, which is likely to be lower when States compete than otherwise.

No change in prices

Three, contrary to common belief, the prices that consumers pay don’t rise or fall in tandem with taxes imposed on goods, be they production or consumption taxes. Consumer prices are determined purely by consumer demand, not the cost of production. It is true that a discriminatory tax might force businesses to discontinue or reduce the supply of certain goods in favour of others.

Such distortion of production can lead to the rise in the prices of certain goods (due to lower supply) and a fall in the prices of others (due to greater supply), which is clearly not the same as a general increase in prices. Which brings us to the final point point. It is true that multiple taxes across and within States can distort production, but the benefits in the form of lower tax rates are likely to outweigh the costs of such distortion.

A bigger, but imperfect, economic pie may be preferable to a smaller, but perfect, one.

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Printable version | Oct 17, 2021 12:14:11 AM |

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