Overview of GST Reform in India

The introduction of the Goods and Services Tax (GST) in India aimed to enhance consumption and production efficiencies via a destination-based tax system. The intent was for the tax incidence to fall on final consumers, with input taxes being rebated. However, issues with the GST arose due to a complex compensation cess mechanism, multiple tax rates, an inverted duty structure, and high compliance costs.

Revised GST Rate Structure

• Effective from September 22, 2025, significant changes in the GST rate structure include: 
  • The discontinuation of the 12% and 28% rates.
  • Continued rates of 0%, 5%, and 18%, with adjustments in the goods and services covered under these rates.
  • A demerit rate of 40% for sin goods and luxury items.
  • Continuation of special rates below 5% for certain goods.
• Sectors likely to benefit: 
  • Employment-intensive sectors: textiles, consumer electronics, automobiles, health, and most food items.
  • Production sectors: fertilizers, agricultural machinery, and renewable energy, benefiting farmers with reduced input costs.

Impact on GST Revenues

Revised rates affect GST revenues by altering both the tax rate and the tax base (final consumption expenditure). As tax rates decrease, post-tax prices are expected to drop, leading to increased demand. However, for feasible demand elasticity ranges, revenues are expected to fall. Where tax rates are reduced to nil, revenues will be zero.

Revenue Implications

• Most rate increases, such as from 28% to 40% for luxury goods, involve merging compensation cess into the tax rate, rather than genuine rate hikes.
• Estimated net revenue loss, as per the Ministry of Finance, stands at ₹48,000 crore annually, with other estimates suggesting higher losses.
• Consumers are expected to increase demand for goods in higher rate categories over time, countering immediate revenue loss.

Economic Growth and Fiscal Implications

• The new GST structure does not totally eliminate cascading effects. Exemptions prevent input tax credits, inflating prices for final goods.
• Revenue shortfalls may affect India’s fiscal deficit for 2025-26, with GDP growth and direct tax collections underperforming budget targets.
• Options to manage shortfall: 
  • Reduce government expenditure.
  • Increase fiscal deficit, potentially resorting to borrowing or expenditure cuts at the state level.

Conclusion

The GST reform is envisioned as a landmark in India’s tax journey, targeting enhanced growth through improved resource allocation, despite potential short-term fiscal challenges. The strategy to bolster growth via tax rate reductions is limited and relies heavily on investment and saving rates.