No one knows yet if the implementation of the goods and services tax (GST) will be inflationary. The Government would like us to believe it will not be. Because multiple taxes at the Central and State levels are to be subsumed into GST, and full credit allowed for taxes paid through the value chain to businesses, the cascading effect would mostly end when the new taxation regime replaces the existing one. The lower impact of cascading taxes would normally have a calming effect on prices and even lower several prices, thus cooling inflation. Taxes on services would be higher and so there would be some inflationary push from services consumption.
However, consumption is not limited to tax-paid items and services from the formal sector. A large part of the economy is cash-based, where invoices are rarely issued by the seller of goods or provider of services. This holds true for business-to-consumer transactions and for business-to-business also. Many businesses choose to buy from such vendors as it means getting things cheaper. GST disincentivises evasion and increases compliance. Vendors who are not GST-compliant run the risk of losing business because those buying from them will not get input credit for taxes paid. Therefore, to protect their business and maintain revenue growth, it is expected many vendors will embrace GST.
While that would be good for the entire value chain, someone must bear the taxes on all such goods and services. Since GST is a consumption tax, it will be the final consumer of that good or service, namely, the household that would bear the tax. That could push up the prices of some items in the household basket. Consequently GST, even after lowering taxes on many items, may increase the inflationary pressure felt by a household — particularly by those in the lower income groups that are more likely to be consumers of informal sector goods and services.