Too much profit?

June 22, 2017 12:00 am | Updated 03:37 am IST

The GST’s ‘anti-profiteering’ clause makes no economic sense

Businesses that receive the benefit of paying lower taxes under the new goods and services tax (GST) regime can’t keep it with them. Instead, according to the GST Act, they must pass it on to consumers by reducing the price of the products they sell. “Any reduction in rate of tax on any supply of goods or services or the benefit of input tax credit,” the Act reads, “shall be passed on to the recipient by way of commensurate reduction in prices.” If any business fails to comply with this rule, authorities from the National Anti-Profiteering Authority (NAPA) will use the “anti-profiteering” clause of the Act to take action against them — by ordering a reduction of prices, imposing penalties, or even cancelling a company’s registration. The supposed intent of the clause is to prevent price rise induced by the imposition of the new national tax. In order to offset the higher taxes imposed on certain goods, the government wants to make sure consumers receive the benefits of lower taxes on other goods.

The only problem is that the anti-profiteering clause makes no economic sense. It assumes that lowering the tax rate on businesses will improve their profit margin, so they should not complain about lowering prices. While it is true that a reduced tax rate can improve profit margins, it does not follow automatically that prices need to fall. This is because pricing decisions are based solely on consumer demand for a product, not the cost of production. Businessmen do not sell their products at a higher or lower price because their cost of production has changed after a change in the tax rate. In fact, it is the likely price that consumers will pay for a product that determines what businessmen will pay for its inputs. This is why the NAPA has been empowered to muscle businesses into lowering prices.

Aggressive stance

The government has also been aggressive in its rhetoric against businesses hoping to profit from lower taxes. “We expect companies to cooperate. We hope we don’t have to use the weapon,” said Hasmukh Adhia, the Union Revenue Secretary, in a veiled threat. Simply put, the NAPA will soon be forcing businesses it targets to sell products at lower prices. Contrary to the intention of the anti-profiteering clause, this will not benefit consumers. Shortages are likely to follow as prices fall without a commensurate increase in supply. This is because profit-capping will distort business returns, thus discouraging new investment that could help ramp up production. In contrast, when the tax rate is reduced without a cap on profits, it usually leads to a similar fall in prices, but without shortages. This is because higher profit margins — due to lower taxes — attract new investment and increase supply.

Another fallout will be corruption and inefficiency as the government begins implementation of the clause. Bureaucrats with the power to interfere in the market will likely increase the burden on businesses than improve consumer welfare. This does not portend well for doing business in India.

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