Arun Kumar
Changes in GST slabs by itself will be inadequate to face the challenge of the penal tariffs proposed by the US.
There is much talk of the proposed simplification of India’s complex GST regime. Prime minister Narendra Modi in his Independence Day speech, said, “…The government will implement next generation GST reforms which will bring down tax burden on the common man.” The 12% and 28% tax slabs are to be eliminated leaving broadly four rates of tax – 0%, 5%, 18% and 40%. The ideal GST which should have a single rate of tax is not yet feasible given the complexity of the Indian economy. The average rate of tax is set to fall and if the producers pass on this benefit to the consumers, goods and services would cheapen thereby boosting demand and leading to higher production.
But immediately, demand in the economy will decline as buyers postpone purchases of higher value items to take advantage of the likely fall in prices when the new tax regime kicks in. The ongoing stocking by dealers for the festive season will stop and the stocks already accumulated are likely to pose a problem.
The gap between announcement and reduction of tax rates is because it is the GST Council, consisting of the Union government and the states, that has to take the decision for implementing the change. The Council is due to meet early September, and the Centre is in a position to push forward the changes proposed by the PM. But, the states will have to contend with a reduction in their tax revenue at a time when they are fiscally constrained due to the high debt to GSDP ratio. The Union government will also face this problem but it has many more ways of bolstering its revenues, like, dividend from the RBI.
A Laffer curve argument is invoked to argue that with lower rates of taxes, revenue collection will rise. This is a red herring. GST itself was supposed to check black income generation and boost tax revenue but that has not come about. The direct tax to GDP ratio should have sharply risen but that has not happened. There are frequent reports of fake companies, etc., proliferating to evade taxes.
The call for reform of GST is not new. So, why the announcement at the present juncture? It is a part of an atmanirbharta package which signals a shift in the nation’s approach to globalisation and exports, given the stress caused by president Trump’s bullying and protectionist moves.
Not only are exports to the USA, India’s largest market, threatened, even exports to other markets, like the EU, are likely to decline. US exports to the EU and Japan will be at zero duty and will offer greater competition to others. Further, exports to the US by all other countries facing high tariffs are set to decline. So, exporters from EU, Japan, China, etc., will have surpluses which they will try to sell to others at discounted prices. This will impact Indian exports, unless the government steps in with subsidies.
This is the context within which lower GST rates may help counter the loss of demand due to lower exports. GST is an indirect tax and is regressive. A cut in its rates resulting in lower prices (assuming the benefit is passed on to the consumers) is expected to boost demand from all consumers. There is a precedent for this. In 2007-08, during the global financial crisis, indirect taxes were cut and the fiscal deficit was allowed to rise to boost demand to cushion the GDP decline. It worked and the Indian economy did not go into a recession.
But the present proposal has a problem. Simplification of the GST regime is not the same as its structural reform. While the former is required, it is the latter that is crucial to boost the economy.
Indian GST’s complexity is due to the huge size of its unorganised sector, something no other major economy has.
Poverty is entrenched in this sector so that its production and consumption needs protection. Due to this reason, this sector is either exempted from GST or it pays a nominal tax under ‘composition scheme’. But that has meant that its producers neither get input tax credit (ITC) nor can they offer it to those buying from them. Consequently, its produce becomes relatively more expensive than that of the organized sector. Not only that, if the organised sector buys from it, it has to pay ‘reverse charge’ which increases working capital requirement. The result is a shift in demand from the unorganised to the organised sector.
In brief, GST is largely paid by the organised sector. As Arun Jaitley famously said, 5% of the units pay 95% of the GST. It is these units that will receive the benefit of cut in GST rates and not the declining unorganised sector units. The poor who mostly consume the produce of the unorganised sectors will also not receive the benefit. So, while the PM has flagged the problem faced by the micro and small units, they are not going to benefit from the proposed revision in GST slabs.
Finally, the loss of revenue could raise the fiscal deficit and check that budgetary expenditures on social sectors may be curtailed. That would increase unemployment and reduce demand, countering the boost from cuts in GST rates. The alternative is to allow the fiscal deficit to rise and/or raise additional direct taxes.
In brief, GST needs structural reform, as this author has been arguing since 2015. Changes in GST slabs by itself will be inadequate to face the challenge of the penal tariffs proposed by the US.
This piece was first published on The WIRE as GST Needs Reform, Not Just Reduction in Slabs on Aug 29 2025
Arun Kumar is a former professor of economics at JNU and author of Ground Scorching Tax (2019).*
Disclaimer: All views expressed in the article belong to the author and not necessarily to the organisation.
Acknowledgement: This article was posted by Aashvee Prisha, a research intern at IMPRI.
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