Impact of 2025 GST Cut on India’s Economy

The Goods and Services Tax (GST) cut implemented on 22 September 2025 has sparked widespread approval for reducing taxes on most consumption items. Official estimates and expert analyses predict a revenue loss of around Rs 1 trillion over the next year. However, detailed studies using unit-level consumption data suggest the loss could be much higher, near Rs 10 trillion. This discrepancy raises important questions about tax policy, economic growth, and fiscal sustainability in India.

Background of the GST Cut

The 2025 GST reduction aimed to lower the effective tax rate on consumption from 11 per cent to around 6.2 per cent. This was intended to boost consumer spending by making goods and services more affordable. The government expected a moderate fiscal impact, estimating a revenue loss of less than half a per cent of the pre-reform GST collection, which was projected at Rs 23 trillion for 2025-26.

Analysis of Consumption Data

Using unit-level data from the National Sample Survey (NSS) 2022-23 and PRICE’s ICE 360 survey, analysts matched household consumption with pre- and post-GST tax rates across 364 items in 37 categories. Market-purchased consumption was the focus, excluding household production. Results showed a sharp decline in effective tax rates, especially in essential sectors like food (from 9.5% to 3.4%), education and medical expenses (from 12.4% to 4.8%), and household services (from 39.5% to 11.3%).

Discrepancy in Revenue Loss Estimates

Contrary to official optimism, the detailed data analysis projects a tax revenue loss of about Rs 10 trillion. Experts argue that increased consumption and better compliance will offset losses. However, economic theory and consumption patterns suggest only a partial recovery. Increased disposable income may be split roughly equally between consumption and savings, limiting additional tax revenue gains to around Rs 0.31 trillion. Even with adjustments for input tax credits, the net loss remains higher than official estimates.

Macroeconomic Context and Implications

A key factor affecting tax revenue is the broader economic environment. India, like many countries, faces a low inflation trap, slowing nominal GDP and consumption growth. Demographic shifts, technological advances, and global uncertainties also dampen growth prospects. This environment reduces the likelihood of strong tax revenue growth from consumption increases.

Taxation and Growth Linkage

India’s high tax-to-GDP ratio (around 18-19%) compared to East Asian economies (13-15%) has been a growth constraint. The GST cut and earlier income tax reductions are expected to lower this ratio to about 15.5-16.5%, closer to China’s levels. Lower tax burdens can enhance productivity and growth by encouraging investment and consumption.

Policy Outlook and Structural Reforms

The GST cut is part of a broader stimulus to counter trade tensions and economic slowdown. The government’s focus on minimum government, maximum governance marks the need for deeper reforms. Trade liberalisation, tariff rationalisation, and investment reforms are critical to complement tax cuts. Self-reliance alone cannot drive growth; integration with global markets remains essential for India’s development goals.

Questions for UPSC:

1. Discuss the impact of indirect tax reforms like GST on economic growth and fiscal health in developing countries.
2. Critically examine the relationship between tax-to-GDP ratio and productivity growth with examples from emerging economies.
3. Explain the concept of inflation tax and its relevance in the context of low inflation environments in India and globally.
4. With suitable examples, discuss the role of structural reforms in complementing fiscal policy measures for sustainable economic development.

Answer Hints:

1. Discuss the impact of indirect tax reforms like GST on economic growth and fiscal health in developing countries.

1. GST simplifies the tax structure by subsuming multiple indirect taxes, reducing compliance costs.
2. Lower GST rates can boost consumption by making goods and services more affordable, stimulating economic growth.
3. Initial revenue loss from tax cuts may occur, but improved compliance and formalization can offset losses over time.
4. Effective GST implementation enhances transparency and reduces tax evasion, strengthening fiscal health.
5. In developing countries, GST promotes a unified market, encouraging investment and ease of doing business.
6. However, poorly calibrated GST cuts can widen fiscal deficits if not accompanied by expenditure reforms.

2. Critically examine the relationship between tax-to-GDP ratio and productivity growth with examples from emerging economies.

1. High tax-to-GDP ratios can discourage investment and entrepreneurship, slowing productivity growth.
2. Emerging economies like China have maintained moderate tax ratios (~15%) supporting rapid growth and productivity gains.
3. India’s higher tax-GDP ratio (~18-19%) is argued to constrain its growth potential compared to East Asian peers.
4. Lower tax burdens free up resources for private sector innovation and capital formation, boosting productivity.
5. However, very low tax ratios may impair government’s ability to invest in infrastructure and human capital.
6. Optimal tax-to-GDP balance is crucial to sustain growth without undermining fiscal capacity or productivity incentives.

3. Explain the concept of inflation tax and its relevance in the context of low inflation environments in India and globally.

1. Inflation tax refers to the erosion of real value of money holdings due to rising prices, effectively taxing cash holders.
2. It acts as a hidden revenue source for governments during high inflation periods.
3. In low inflation or deflationary environments, inflation tax revenue declines, reducing government fiscal space.
4. India and many countries face a low inflation trap, limiting nominal GDP growth and inflation tax benefits.
5. Reduced inflation tax necessitates reliance on explicit taxes, increasing pressure on formal tax systems like GST.
6. About inflation tax is important for fiscal planning and managing public debt sustainability.

4. With suitable examples, discuss the role of structural reforms in complementing fiscal policy measures for sustainable economic development.

1. Structural reforms improve economic efficiency by removing bottlenecks in labor, product, and capital markets.
2. Examples – India’s GST reform unified indirect taxes, improving ease of doing business and tax compliance.
3. Trade liberalization and tariff rationalization enhance competitiveness and attract foreign investment.
4. Labor market reforms increase employment flexibility and productivity.
5. Complementing fiscal stimulus with reforms ensures sustainable growth without causing fiscal imbalances.
6. Without reforms, fiscal measures risk being short-term fixes, failing to address underlying structural constraints.