India’s Prime Minister Narendra Modi recently announced major reforms to the Goods and Services Tax (GST) system. This announcement came ahead of formal approval from the GST Council. The reforms aim to simplify the current complex multi-rate GST system just before the festive season. These changes are expected to impact consumers, businesses, and the overall economy.
Current GST Structure and Proposed Changes
Since its introduction in 2017, India’s GST has had multiple tax slabs ranging from 5% to 28%, plus additional compensation cess. The proposed reform plans to reduce this complexity by adopting a two-rate system of 5% and 18%, with a special 40% rate for select items. The 12% and 28% slabs are to be eliminated. This simplification is expected to reduce confusion among taxpayers and improve compliance.
Challenges of a Two-Rate GST Model
While simpler, the two-rate system carries risks. The large 13 percentage point gap between 5% and 18% could encourage tax evasion. It may also create an inverted duty structure where output GST rates are lower than input GST rates, complicating tax credits. Without a strong automatic refund mechanism, businesses may face cash flow issues. India’s history of false input tax credit claims adds to the challenge of implementing such a system effectively.
Input Tax Credit Mechanism Overhaul
Input Tax Credit (ITC) is central to GST’s value-added tax design. Currently, India’s ITC system is complex and restrictive. Experts suggest expanding ITC eligibility to cover almost all business inputs, barring a small negative list. This would prevent tax cascading, reduce costs for suppliers, and ultimately benefit consumers. A streamlined ITC system is essential for GST’s success.
Expanding GST’s Tax Base
Certain major sectors like petroleum, electricity, alcohol, and real estate remain outside GST’s scope. Including these sectors would eliminate multiple layers of taxation and boost economic efficiency. However, political and fiscal challenges have delayed their inclusion. Greater cooperation between the Centre and states is needed to integrate these sectors into GST and unlock India’s full growth potential.
Economic Impact and Federal Cooperation
The GST reforms aim to make Indian goods and services more competitive domestically and internationally. Simplifying the tax regime can attract investment and support India’s ambition to become an economic superpower. Achieving this requires cooperative federalism, with states and the Centre working together to implement reforms swiftly and fairly.
Questions for UPSC:
- Point out the challenges faced in implementing a uniform Goods and Services Tax in a federal country like India and suggest measures to overcome them.
- Critically analyse the impact of cascading taxes on economic growth and how the GST system addresses this issue with suitable examples.
- What are the key features of the Input Tax Credit mechanism under GST? How does it influence business operations and tax compliance?
- Estimate the role of cooperative federalism in fiscal reforms in India. With suitable examples, underline its importance in implementing nationwide tax policies.
