India implemented a new Goods and Services Tax (GST) rate structure from September 22, 2025. This reform aims to simplify the tax system and boost consumption and production efficiency. The new rates eliminate the 12% and 28% slabs, retaining 0%, 5%, and 18% with some modifications. A 40% demerit rate applies to sin and luxury goods. This change affects multiple sectors and has broad economic implications.
Overview of GST Reforms
GST is a destination-based tax, levied on final consumption. It replaced earlier indirect taxes to avoid cascading and improve compliance. The 2025 revision reduces tax rates on most goods, benefiting consumers and producers. About 80% of goods saw rate cuts, while 20% faced increases. Special rates below 5% continue for select items. The demerit rate targets luxury and sin goods. The reform focuses on sectors like textiles, electronics, automobiles, health, fertilisers, and renewable energy.
Impact on Prices and Consumption
Lower tax rates reduce post-tax prices, making goods more affordable. This price drop tends to increase demand, especially in employment-intensive sectors. However, the price reduction is smaller than the tax rate cut due to input taxes and market factors. Goods moved to the zero rate category generate no GST revenue. Demand elasticity influences the extent of consumption growth. Necessities in the 5% bracket have low demand elasticity, so income gains may shift spending towards higher-taxed luxury goods.
Revenue Implications
GST revenue equals the tax rate multiplied by the tax base (consumption expenditure). Rate cuts reduce revenues directly and indirectly through increased consumption. Estimates suggest a revenue loss of around ₹48,000 crore annually, with some projections higher. Increased disposable income may eventually boost revenue as consumers spend on higher-taxed goods. However, this revenue gain is gradual. The merger of compensation cess into the 40% rate does not represent a real tax hike but a structural change.
Challenges in Input Tax Credit and Cascading
Zero-rated and exempt goods complicate input tax credit (ITC) claims. Taxes on inputs often remain at 18%, increasing costs for producers of low-rate goods. This undermines the goal of eliminating cascading taxes fully. Bottlenecks in ITC claims persist, affecting price competitiveness. Classification of goods should be based on their nature, not temporary demand fluctuations, to ensure tax fairness.
Macro-Fiscal Effects
The GST reform may pressure the central and state budgets, increasing fiscal deficits. Early 2025-26 data shows slower GDP growth and contraction in direct taxes. Combined with personal income tax reforms, overall tax revenue may fall short of budget targets. States might need to borrow more or cut spending, risking lower real growth. Monetary easing to support growth could raise inflation and fiscal monetisation risks. Sustainable growth depends on higher savings, investment, and efficient capital use rather than repeated tax cuts.
Sectoral Beneficiaries
Textiles, consumer electronics, automobiles, health, and food sectors gain from lower GST rates. These sectors employ many people and will benefit from increased demand. Agricultural inputs like fertilisers and machinery, along with renewable energy, will see reduced costs, aiding farmers and green initiatives. These changes aim to balance growth with social welfare.
Questions for UPSC:
- Point out the significance of destination-based taxation in Goods and Services Tax and its impact on inter-state trade in India.
- Critically analyse the challenges in implementing input tax credit mechanisms under GST and suggest measures to improve compliance.
- With suitable examples, estimate the macroeconomic consequences of reduction in indirect tax rates on government revenue and fiscal deficit.
- Underline the role of tax reforms in promoting employment-intensive sectors and analyse their impact on inclusive economic growth in India.
