Dipak Kurmi
When Prime Minister Narendra Modi, in his Independence Day address, pledged structural reforms of the Goods and Services Tax (GST), his words resonated with both urgency and ambition. The assurance that GST 2.0 would lower prices, boost consumption, and drive India’s GDP growth arrives at a time when the nation is confronted with global economic headwinds, particularly the stiff stance of the United States in imposing penal import tariffs on Indian goods. At home, the challenge is no less daunting: to evolve GST into a framework that is simpler, fairer, and more efficient without destabilising the fragile balance of consumer welfare, government revenues, and state fiscal sovereignty.
The GST Council, chaired by finance minister Nirmala Sitharaman, has convened this week to deliberate on a new structure for GST 2.0. It is a momentous task, for the Council must chart the next phase of a tax reform that, since its implementation in fiscal 2017–18, has already transformed India’s indirect taxation landscape. GST 1.0 replaced a labyrinth of levies—state VATs, excise duties, service tax, entry tax, octroi, and others—with a single value-added tax applicable nationwide. This radical consolidation addressed the inefficiencies of a fragmented system, reduced transaction costs for businesses, and reinforced the idea of India as a unified common market.
Achievements and Persistent Challenges
The achievements of GST 1.0 are not negligible. Its value-added design eliminated the pernicious cascading effect of taxation, where tax was levied on tax. Under GST, businesses can claim input tax credits, linking purchase invoices with sales invoices, and thereby reducing the overall burden on final consumers. This mechanism has also discouraged cash-based, unbilled transactions, enlarging the formal tax base and augmenting revenues. The very architecture of GST has nudged the economy toward greater transparency and accountability.
Yet, six years after its inception, the structure of GST remains riddled with complexities. The most glaring challenge lies in its multiplicity of rates. Presently, GST operates with six principal slabs: zero per cent for unprocessed agricultural products and essential social services; five per cent for high-volume, low-margin essentials and daily needs; 12 per cent for garments, processed food, and telecom services; 18 per cent for consumer durables, IT services, and capital goods; and 28 per cent for “sin” and luxury goods, including automobiles, tobacco products, and coal. In addition, gold, silver, cut diamonds, and jewellery attract a special concessional rate of 1–3 per cent.
Such a fragmented rate structure fosters misclassification disputes and increases administrative costs. Taxpayers often attempt to shift products into lower slabs, leading to litigation and compliance burdens. Moreover, collection efficiency—defined as the share of tax actually collected compared to the theoretical potential—remains modest at around 60 per cent. This mirrors the experience of many European economies with multiple GST or VAT rates, where efficiencies hover around the same level. In Brazil, another large developing economy, collection efficiency is even lower, at under 40 per cent.
By contrast, nations with single-rate GST regimes achieve far higher efficiencies. New Zealand, with a uniform 15 per cent rate, boasts collection efficiency of 77 per cent, while South Africa achieves an extraordinary 98 per cent with the same single-rate structure. The United Kingdom, though it maintains three rates, still manages to secure an efficiency of 70 per cent—demonstrating that strong institutional mechanisms can offset some of the disadvantages of multiple rates. India’s predicament thus underscores the need for reform: while its federal structure may demand flexibility, the inefficiencies of its multi-rate system cannot be ignored.
Expanding the Tax Base: The Alcohol and Fuel Dilemma
One area of potential transformation is the inclusion of alcohol and petroleum fuels under GST 2.0. At present, these remain outside its purview, largely because they constitute about 40 per cent of the “own revenues” of state governments, anchoring their fiscal sovereignty. Together, alcohol and petroleum account for nearly five per cent of India’s GDP. If brought under GST, they could expand the taxable base by 12 per cent—from Rs 140 trillion to Rs 157 trillion—and boost revenues by 60 per cent, from Rs 25 trillion to Rs 40 trillion.
Yet, political economy realities complicate this straightforward economic logic. States fear losing control over their most lucrative revenue sources. The experience of GST 1.0, where the Centre had to guarantee states a 14 per cent annual growth in revenue to secure their participation, remains fresh. Replicating such generous compensation in an era of low inflation and fiscal pressures may be neither desirable nor feasible. Nevertheless, the rise of electric mobility and renewable energy threatens to erode petroleum revenues in the medium term. States may eventually have no choice but to negotiate a “grand bargain” under which alcohol and petroleum are subsumed into GST, with safeguards for buoyancy and a rebalancing of voting powers in the GST Council to reflect federal equity.
Agriculture remains another frontier, though politically and economically sensitive. For now, its exclusion reflects the sector’s informality and subsistence character. Only once Indian agriculture transforms into a commercially viable, profit-oriented enterprise can it be meaningfully integrated into GST. Until then, exempting it helps protect vulnerable farmers from inflationary shocks.
The Restructuring Proposals: GST 2.0
Reform, therefore, must balance consumer relief, efficiency, and revenue stability. The State Bank of India’s research division has proposed a restructuring model that collapses the existing six rates into five. The 12 per cent rate, which covers garments, processed food, and telecom services, would be eliminated, with products in this bracket shifted to the five per cent slab. This change would cover around five per cent of the tax base and directly reduce the burden on consumers.
Simultaneously, the highest rate of 28 per cent, accounting for 15 per cent of the tax base, would be dismantled. Two-thirds of the goods in this bracket would move to the 18 per cent slab, while the remaining five per cent—comprising luxury goods, automobiles, and “sin” products like tobacco—would be taxed at a newly introduced 40 per cent rate. The effect of this restructuring would be strikingly progressive. Around 80 per cent of consumers would experience no change in their tax burden. Another 15 per cent of purchases, mostly in mid-range categories, would see tax reductions of 7–10 per cent, creating an “income effect” that could spur consumption. Only five per cent of purchases, concentrated among wealthier households, would bear a heavier burden through the steep 40 per cent “sin tax.”
This design cleverly preserves revenue neutrality while redistributing tax incidence in favour of the middle class and low-income groups. However, critics caution that this remains a form of clever accounting rather than deep structural reform. The persistence of multiple rates—even if fewer than before—means that classification disputes and administrative costs will continue. The long-term efficiency gains that could flow from a single or dual-rate system remain compromised.
Revenue and Inflationary Implications
The SBI study estimates that GST 2.0 could initially create a revenue shortfall of up to Rs 1.1 trillion annually. However, this gap might be offset by the stimulus effect of lower tax rates on 15 per cent of the tax base, boosting consumption and, by extension, revenue. Weighted average GST rates have steadily declined—from 14.4 per cent at inception to 11.6 per cent in 2019, and now projected at 9.5 per cent under GST 2.0. This trajectory signals a steady easing of the tax burden on consumers.
The inflationary impact, meanwhile, is estimated at a modest 0.25 percentage points, a level that policymakers may consider acceptable given the potential benefits in terms of demand expansion and formalisation. Yet, industries such as automobiles have voiced concern about demand compression if their products are subjected to the punitive 40 per cent “sin tax.” Balancing industrial growth with progressive taxation remains a delicate act.
Lessons from International Experience
International comparisons provide perspective. The European Union’s VAT systems, with multiple rates and exemptions, achieve collection efficiencies similar to India’s, illustrating the systemic costs of complexity. New Zealand and South Africa’s success with single-rate GST shows the potential rewards of radical simplicity, but their smaller size and unitary structures make direct transplantation impractical for India. The UK’s relatively strong performance with three rates highlights the importance of robust institutions, streamlined compliance, and an effective digital backbone. India’s GST Network (GSTN), though path-breaking, continues to face challenges of integration, data reconciliation, and user-friendliness. Strengthening this digital architecture could significantly enhance efficiency even within a multi-rate system.
Federal Equity and Cooperative Reform
A critical dimension of GST reform lies in its federal character. States differ widely in their income levels, consumption patterns, and reliance on different commodities for revenue. Any restructuring of GST will therefore create winners and losers across states. For example, industrialised states with large consumer bases may benefit disproportionately from a broad-based GST, while resource-rich but less industrialised states may feel disadvantaged.
To sustain cooperative federalism, the finance minister would do well to pledge that no state will be left worse off under GST 2.0. Compensation mechanisms, though more modest than in the past, must ensure revenue neutrality for states in the short to medium term. Over time, states will need to diversify their revenue sources beyond alcohol and petroleum, especially as global energy transitions accelerate. A transparent, rules-based compensation framework, combined with greater state representation in decision-making, can cement trust in the reform process.
The Road Ahead
GST 2.0 represents both a challenge and an opportunity. Its challenge lies in reconciling competing objectives: reducing consumer tax burdens, enhancing efficiency, and safeguarding revenues. Its opportunity lies in advancing India’s economic integration, strengthening formalisation, and equipping the country to weather global economic turbulence.
For the government, the stakes are high. A simplified, progressive GST could help counter the effects of American protectionism by making Indian goods more competitive through lower domestic costs. For consumers, the promise of lower taxes on essentials and durables could boost disposable incomes and stimulate demand. For industry, predictability and reduced compliance burdens could improve the ease of doing business. And for states, carefully crafted safeguards could preserve fiscal autonomy while aligning their incentives with national growth.
Ultimately, the true structural reform of GST will not be measured merely by the number of tax slabs or the percentage points shaved off rates. It will be judged by whether India succeeds in building a tax system that is transparent, efficient, equitable, and resilient—capable of financing development without distorting consumption or investment. GST 2.0 may not be the final destination, but it is an important milestone in India’s journey toward a smarter and fairer tax regime.
(The writer can be reached at dipakkurmiglpltd@gmail.com)
