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The nationwide Goods and Services Tax (GST) was rolled out eight years ago with much fanfare in a special midnight session of Parliament. It was hailed as a landmark reform of the tax system. It unified the country as a common economic market with one system of indirect taxes, eliminating inter-State frictions and also leakages. The passage of GST reform was achieved as a grand bargain with the Union government giving up its right to impose excise and service taxes, and all the States surrendering their right to impose State-level sales taxes, value added tax and other sundry taxes such as octroi.
We need to explore how to restore greater fiscal space and autonomy to States, enabling them to design policies suited to their specific economic, social, and regional needs
This grand bargain and persuasion of State governments to surrender their taxing autonomy was achieved by promising them reimbursements of tax shortfalls. This is the GST compensation clause in the original Act of 2017, which expired in 2022. Now the States are afraid that they will face a steep fall in their tax share of GST.
The unified national tax system was implemented by giving up VAT, entry tax and octroi. Previously, States could adjust these taxes to meet their unique fiscal needs. Now, their ability to independently mobilise resources is curtailed and that is a cause for worry. After eight years, the GST is still like a work in progress despite the great efforts of the GST council with representatives of all States.
The government’s proposal revolves around three pillars: structural reforms, rate rationalisation, and ease of living
In this light it is very welcome that Prime Minister Narendra Modi, in his Independence Day address, announced a landmark reform of GST as a major “Diwali gift” for the citizens. He promised next-generation GST reforms aimed at reducing the tax burden on the common people, especially the middle class and MSMEs. The government’s proposal revolves around three pillars: structural reforms, rate rationalisation, and ease of living.
Let’s be clear that GST as a unified, nationwide, indirect tax has certain drawbacks, from both the design and implementation perspective. The design flaw is that an indirect tax like GST is inherently regressive. That's because the tax paid does not depend on the income of the person, but on the value of the item being purchased. Hence the poor feel the pinch of GST more than the rich. Direct taxes like income tax and wealth tax are more fair than indirect taxes. Fairness means the *fraction* of your income paid as taxes, goes up with income, not down.
The divide between essentials and non-essentials is anyway not sharp, nor static, nor something the State should determine
To reduce this unfairness, the GST design has multiple slabs. A zero or 5% slab on items consumed by the poor. And a high slab for items consumed by the rich. This is to make GST fair, by using the consumption choices of the poor as a proxy for their income. But it is paternalistic. It implicitly dictates what poor people should consume. What if poor households have aspirations?
An indirect tax like GST is inherently regressive. That's because the tax paid does not depend on the income of the person, but on the value of the item being purchased. Hence the poor feel the pinch of GST more than the rich
The divide between essentials and non-essentials is anyway not sharp, nor static, nor something the State should determine. With GDP growth, poor households move into the middle-income slab and the middle-income households into the rich. So instead of catching their income, we try to get them through GST.
In practice worldwide, food and medicines are exempt. A rational, efficient system should have only one rate for all goods and services. This is seen in the EU nations, Singapore, Australia and other countries. There are some tweaks, but the broad principle is one median rate, one very low rate for essentials (food, medicine) and one very high rate for sin goods (tobacco, liquor) and super luxury goods.
The current GST structure is difficult to administer and regressive in effect
From an implementation perspective the flaws in India are as follows. We have multiple slabs, large exemptions from parts of GDP, inverted duties, and finally an excessive burden of compliance especially on small businesses. The GST system in India has retained a complicated system of multiple tax slabs (0%, 5%, 12%, 18%, 28%, a penal sin tax rate and various cesses). This complexity leads to frequent disputes over the classification of goods and services, confusion among taxpayers, and litigation.
The legal cases have already clogged the system. The current GST structure is difficult to administer and regressive in effect. There are also cases of prevalence of inverted duty structures under GST, where inputs are taxed at higher rates than finished goods. This leads to accumulated credits, cash flow problems for businesses, and discourages domestic manufacturing.
Large parts of GDP such as agriculture, petroleum products, electricity, alcohol and real estate remain outside its ambit. Selective exemptions fragment the tax base, reduce revenue, and undermine the spirit of GST reform. The burden on small businesses and MSME’s is severe since they have to pay GST upfront but their customers delay payments. There are also delays in refunds and technical glitches which hurt business liquidity and confidence. Additionally frequent changes in rates and rules, along with a complex filing system, pose additional burdens and lead to further tax litigation.
Large parts of GDP such as agriculture, petroleum products, electricity, alcohol and real estate remain outside its ambit. Selective exemptions fragment the tax base, reduce revenue, and undermine the spirit of GST reform
Under the proposed reforms announced by the PM on independence day, the most significant change is the move from the current multi-slab GST system to a simplified two-slab structure: a “standard” and a “merit” rate, with special rates for a select few items. This will make compliance easier for businesses, reduce litigation and classification disputes, and bring much-needed stability and predictability to GST rates.
Taxes on daily-use items and aspirational goods are expected to drop, boosting consumption and benefiting MSMEs. Lowering these rates will help make Indian exports more competitive globally and aid job creation. The government also plans to introduce seamless, technology-driven registration, pre-filled GST returns, and faster refunds.
It is advisable that the median rate be 15 percent and not 18 which is too burdensome. In fact, the GST median rate should come down from 15 to even 12 as suggested by the original Kelkar task force on tax reforms.
Taxes on daily-use items and aspirational goods are expected to drop, boosting consumption and benefiting MSMEs
Finally, a comment on federalism. The Constitution gives States greater expenditure responsibilities (like health and education) but fewer independent revenue streams. GST has accentuated this imbalance, forcing States to rely heavily on central transfers. States need some taxing power for funding local development and public welfare.
The median rate be 15 percent and not 18 which is too burdensome
There is a perception that GST has undermined India’s federal spirit and eroded the fiscal autonomy of States. We need to explore how to restore greater fiscal space and autonomy to States, enabling them to design policies suited to their specific economic, social, and regional needs. We also need to tilt the balance away from indirect taxes toward direct taxes, to reduce inequity.