India’s Goods and Services Tax (GST) is undergoing its most reform since 2017. Announced by Prime Minister Narendra Modi as a Diwali gift, the plan aims to simplify the tax system by reducing multiple tax slabs to just two main rates. This move addresses long-standing complaints about GST’s complexity and seeks to boost consumption and ease business compliance amid sluggish demand and upcoming elections.
Background and
India introduced GST in 2017 to unify various indirect taxes into a single system. However, the tax structure grew complicated with five different rates, compensation cess, and numerous exemptions. This complexity led to disputes and compliance challenges for businesses and confusion for consumers. The government’s new plan collapses these into two main rates—5 per cent and 18 per cent—plus a high 40 per cent rate on alcohol, tobacco, and other sin goods.
Key Features of the GST Reform
The reform simplifies tax slabs drastically. Essentials like ghee, soap, processed food, and handicrafts fall under 5 per cent to ease household expenses and support small enterprises. Larger items such as refrigerators, cement, and air conditioners move to 18 per cent, down from 28 per cent, reducing costs for housing and manufacturing. The 40 per cent slab remains for sin goods to discourage consumption.
Economic Rationale and Expected Impact
The government’s approach is based on the Laffer curve theory. It expects that lower tax rates will boost consumption and broaden the tax base, eventually increasing overall revenue. Ending the compensation cess paid to states has freed fiscal space to allow these cuts. Aligning GST rates with global norms also aims to protect Indian producers from cheaper imports due to new free trade agreements.
Challenges and Risks
Advance notice of tax cuts has caused market delays. Distributors and consumers are postponing purchases, leading to inventory build-ups. Anti-profiteering rules are in place but enforcing them may be difficult, as seen in other countries. Despite cuts, India’s GST rates remain higher than some Southeast Asian nations, which could limit competitiveness. States face fiscal stress from lost compensation transfers, potentially affecting health and education budgets ahead of elections.
Implementation and Compliance Issues
Reclassifying nearly 1,500 goods and services demands extensive adjustments. Small businesses must update billing systems, software, and train staff. This transition risks confusion and errors. Successful execution is critical to avoid market disruption and maintain state cooperation.
Political and Social Dimensions
The timing of the reform is politically strategic, aimed at appealing to voters by reducing costs on daily essentials and supporting sectors like handicrafts and construction. However, if consumers do not see immediate benefits or if hoarding and profiteering occur, public sentiment could turn negative. States may resist revenue risks, complicating GST Council negotiations.
Long-Term Outlook
Simplifying GST is important step toward achieving the one nation, one tax goal. If implemented well, it could stimulate consumption and ease business burdens. However, the reform’s success depends on smooth execution, market discipline, and state cooperation.
Questions for UPSC:
- Critically discuss the impact of tax reforms like GST on India’s federal fiscal relations and state finances.
- Analyse the role of indirect taxes in promoting economic growth and how simplification affects tax compliance.
- Examine the challenges of implementing large-scale economic reforms in a diverse federal country like India and suggest measures to overcome them.
- Estimate the effects of global trade dynamics and tariff changes on domestic tax policies and manufacturing competitiveness in emerging economies.
