While inflation undoubtedly contributes to increased indirect tax revenue by raising the prices of goods and services.....

 Indirect tax collections in India are influenced by both the Consumer Price Index (CPI) and core inflation, but it's not a simple, direct relationship. Indirect taxes, like GST, are levied on goods and services, and their revenue collection is affected by both overall inflation (as measured by CPI) and the underlying trend of inflation (as measured by core inflation). While CPI reflects the overall price changes consumers experience, core inflation excludes volatile items like food and fuel, providing a clearer picture of underlying inflationary pressures.

Impact of CPI and Core Inflation on Indirect Taxes:

CPI:

A higher CPI, indicating increased prices, generally leads to higher indirect tax revenue. This is because indirect taxes are often levied as a percentage of the price of goods and services. For example, a 10% GST on a product that costs ₹100 will yield ₹10 in taxes. If the price increases to ₹110 due to inflation, the tax collected will also increase to ₹11, even if the tax rate remains the same.

Core Inflation:

Core inflation, by excluding volatile items, provides a more stable measure of inflationary trends. When core inflation is high, it suggests that the underlying cost of goods and services is increasing, which can lead to sustained increases in indirect tax revenue over time, even if headline inflation (CPI) fluctuates due to temporary factors.

Indirect Tax Elasticity:

The responsiveness of indirect tax revenue to changes in prices (and therefore CPI and core inflation) is referred to as tax elasticity. A higher tax elasticity means that indirect tax revenue is more sensitive to price changes.

In India, the Consumer Price Index (CPI) measures retail inflation, while core inflation excludes food and fuel components. Indirect taxes, like GST, have a tax elasticity that indicates how tax revenue responds to changes in tax rates.

CPI and Core Inflation:

CPI:

The CPI reflects the cost of a basket of goods and services purchased by consumers, providing a measure of retail inflation.

Core Inflation:

Core inflation excludes volatile items like food and fuel, offering a more stable measure of underlying inflation trends.

Recent Trends:

In India, headline CPI inflation has recently eased, partly due to lower food prices, but core inflation has remained elevated. For example, CPI inflation fell to 2.8% in May 2025, but core inflation stayed above 4% for four consecutive months.

Indirect Taxes and Tax Elasticity:

Indirect Taxes:

Indirect taxes, such as GST, are levied on goods and services and are a significant source of government revenue.

Tax Elasticity:

Tax elasticity refers to the responsiveness of tax revenue to changes in tax rates or other economic factors. It helps assess how effective tax policies are in generating revenue.

Impact of GST:

The introduction of GST in India has impacted the buoyancy and elasticity of indirect tax collections. Studies have analyzed how GST has affected the overall efficiency and dynamism of the indirect tax system.

Example:

If a 10% increase in a GST rate leads to a 12% increase in tax revenue, the tax is considered elastic (greater than 1). If it leads to a 8% increase, it's considered inelastic (less than 1).

Numbers and Examples:

CPI:

In February 2025, CPI inflation moderated to 3.6%, its lowest in 7 months according to PIB. This moderation would likely have a dampening effect on indirect tax revenue growth compared to periods with higher CPI.

Core Inflation:

In the same period, core inflation crossed 4% for the first time in 14 months, reaching 4.08% according to PIB. This indicates that underlying inflationary pressures are building, which could lead to increased indirect tax collections in the future, even if headline inflation eases due to temporary factors.

Indirect Tax Growth:

Indirect tax collections saw a significant increase of ₹1,20,555 crore (12.56%) during FY21 compared to FY20 says the Comptroller and Auditor General of India. This growth was likely influenced by a combination of factors, including the impact of GST implementation and the overall economic growth, which would be reflected in both CPI and core inflation.

Tax Buoyancy:

An analysis from the Department of Economic Affairs indicates that tax buoyancy (the responsiveness of tax revenue to changes in GDP) increased by 50-80% relative to the average of the previous three years, potentially due to improved tax administration and its impact on indirect taxes according to the Department of Economic Affairs.

1. Inflation's Direct Impact:

Indirect taxes, like sales tax or VAT, are often levied as a percentage of the price of goods and services.

When prices increase due to inflation, the tax base (the value of goods and services being taxed) also increases.

This leads to a higher revenue for the government, even if the consumption volume remains the same.

For example, if a product costs $100 and has a 10% sales tax, the tax revenue is $10. If inflation pushes the price to $110, the tax revenue becomes $11, even if no additional units were sold.

2. Other Influencing Factors:

Changes in Consumption Patterns:

If consumers shift their spending towards taxed goods and services, it will increase tax revenue. For instance, if consumers buy more imported goods, customs duty revenue will increase.

Tax Policy Changes:

New taxes or changes to existing tax rates (like GST implementation in India) can significantly impact tax revenue.

Economic Growth:

A growing economy leads to increased production and consumption, boosting tax collection.

3. Difficulty in Isolating Inflation's Impact:

Because all these factors can change simultaneously, it's challenging to isolate the specific impact of inflation on tax revenue.

For example, if inflation and consumption patterns both increase, it's hard to say how much of the revenue increase is due to inflation and how much is due to increased spending.

To accurately measure inflation's contribution, economists would need to control for these other variables, which is a complex task.

4. Example Scenario (Illustrative):

Let's assume a country has a 5% inflation rate and a 10% sales tax. If the total tax revenue from sales tax was $100 billion last year, and this year it is $115 billion, it's not solely due to the 5% inflation.

If the economy also grew by 2% and consumption increased by 3%, a portion of the $15 billion increase would be attributable to economic growth and increased consumption.

Without further analysis and statistical modeling, pinpointing the exact contribution of inflation would be difficult.

In essence, while CPI and core inflation directly influence the prices of goods and services, their impact on indirect tax revenue is mediated by the tax structure (like GST rates) and the responsiveness of tax revenue to price changes (tax elasticity). While inflation undoubtedly contributes to increased indirect tax revenue by raising the prices of goods and services, pinpointing its exact contribution is difficult due to the influence of other factors. Changes in consumption patterns, tax policy modifications, and overall economic growth also play a significant role in determining the final tax collection figures. Though, inflation does contribute to increased indirect tax revenue, the exact amount is hard to determine due to the influence of other factors. A comprehensive analysis requires considering changes in consumption patterns, tax policy, and overall economic growth to isolate inflation's specific impact.