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GST and the Pass Through Model of Prices

May 25, 2017

Now that the GST rates are out, the economic forecasters are working overtime to evaluate the impact of GST on businesses from consumer goods to manufacturing, from durables to service sectors.

Unfortunately this kind of analysis is very weak as it neither focuses on the impact of input tax credits which will reduce the impact of overall tax incidence, nor does it actually look at how the pass through mechanism would actually work.

The more difficult question would be how the pricing strategies would work, especially when some of the MSMEs who are currently enjoying the free run would now be coming under the ambit of tax, which would mean that their capacity to absorb the cost increase would be limited and the obvious fall out would be that there would be an upward pressure on prices. This works however both ways, which means that they would be quicker to react if it works to their advantage.

Wherever in the world GST got introduced, it created a level playing field for all classes of consumers and suppliers and the biggest beneficiaries were finally the consumers, given that everything remaining the same the consumer had the right to choose from alternatives.

I would assume if this is also going to be the case for India, the pass through mechanism of prices must work, which means, given where the market economy would function, the economics of prices would ordain that benefits cannot be cocooned by any single entity.

If input tax credits helps to lower prices of inputs, it is expected that it would help to cushion off the impact of differential taxes charged by way of GST rates. It could well be the other way round for some sectors , including services.

Competition would ensure that this dynamic is played out to ensure that the most efficient get better off the most inefficient.

Pass through model will ensure that we have a way for MSMEs also to be an integral part of the economics of trade.

After all the small and medium enterprises are part of the Indian economy, which allows the largest pool of people to be employable. Thus it would be good to see how this pass through mechanism of prices work in the next months.

In any case it allows gains to be weighed against losses in one way or the other; pass through is one mechanism to do this efficiently.

This article was first published on LinkedIn by Procyon Mukherjee

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