The Government of India has announced reforms to the Goods and Services Tax (GST) system. The current multi-tier GST rate structure will be simplified to mainly two slabs of 5% and 18%. This change aims to lower the average tax rate and promote ease of doing business. The reforms are expected to affect revenue collections and the fiscal dynamics between the Centre and States. The following notes provide a clear understanding of these reforms and their implications.
Current GST Structure and Proposed Changes
GST currently has four main tax slabs – 5%, 12%, 18%, and 28%. The new proposal seeks to merge most slabs into two – 5% for essential goods and 18% for standard goods. The 28% and 12% slabs will largely be merged into the 18% and 5% slabs respectively. The 18% slab, which contributes about 70% of GST revenue, will remain mostly unchanged to protect revenue flow.
Impact on Revenue and Economic Activity
The average GST rate is expected to drop from about 11.5% to near 10%. This reduction could initially cause a revenue loss estimated between ₹45,000 crore to ₹1,00,000 crore annually, roughly 0.2-0.3% of GDP. However, lower tax rates on essentials and durables are likely to boost consumption. Increased formalisation and compliance may reduce tax evasion. Higher rates on luxury and sin goods will partly offset revenue loss. Overall, the initial dip in revenue is expected to be temporary.
Distribution of GST Revenue Among States
GST revenue is shared between the Centre and States, but not evenly among States. Industrialised States with strong manufacturing and urban centres like Maharashtra, Karnataka, and Tamil Nadu collect more GST. States reliant on agriculture and essentials, such as Bihar and Uttar Pradesh, are less affected by rate cuts. Smaller States with narrower tax bases see minimal impact. Thus, revenue loss from rate cuts will vary widely.
Compensation and Fiscal Autonomy of States
When GST launched in 2017, the Centre guaranteed compensation to States for five years to offset revenue losses. This period has ended, and no further compensation is assured. Experts argue that ongoing compensation for tax rate cuts is unsustainable. States are encouraged to improve tax administration, plug leakages, and broaden their tax base. Some suggest creating contingency funds or special packages from the Consolidated Fund of India to support States facing shortfalls.
Consensus and Future of GST Reforms
The GST Council, which decides GST policies, has largely worked by consensus. The government’s announcement signals readiness to implement reforms soon. While some States may resist due to revenue concerns, the likelihood of the reforms being blocked is low. Discussions may continue on product classifications and timing. The reforms are seen as a step towards simplifying taxation and attracting investment.
Questions for UPSC:
- Critically analyse the impact of GST reforms on the fiscal federalism in India. What are the challenges faced by States in maintaining revenue autonomy?
- Explain the concept of tax rationalisation. How does reducing GST slabs to two rates affect compliance and economic growth in India?
- With suitable examples, comment on the role of indirect taxes like GST in promoting ease of doing business and formalisation of the economy.
- What are the implications of tax rate cuts on government revenue and public expenditure? How can governments balance these in a developing economy?
