Building a Better GST, Progress, Challenges, and the Road Ahead for India’s Tax System

Introduction

India’s Goods and Services Tax (GST), launched in July 2017, was touted as one of the most transformative tax reforms in independent India. It replaced a complex web of indirect taxes levied by the Centre and states with the promise of creating a unified market, boosting ease of doing business, improving compliance, and increasing efficiency in revenue collection.

However, more than six years after its launch, debates around GST continue to dominate India’s political and economic discourse. The system, while successful in creating a single tax umbrella, still suffers from structural flaws, compliance burdens, fiscal federal tensions, and uneven benefits across sectors.

The recent push by the government to reform GST—by collapsing multiple slabs, rationalizing rates, and improving input tax credits—has once again sparked discussions on what the “perfect GST” should look like.

This analysis examines the current state of India’s GST, its successes, its limitations, and the reforms needed to build a more efficient and equitable tax system.

The Promise of GST: Vision vs. Reality

When GST was conceptualized, its architects envisioned:

1. One Nation, One Tax, One Market – ensuring uniform taxation across India.

2. Simplified Structure – a single or low number of tax rates, reducing complexity.

3. Elimination of Cascading – seamless input tax credits (ITC) to ensure no “tax on tax.”

4. Boost to Compliance – digital filing and monitoring to curb evasion.

5. Revenue Neutrality and Growth – ensuring that both Centre and states receive stable revenue while expanding the tax base.

While India has achieved partial success—GST has unified markets and increased compliance—the design compromises made during political negotiations have led to inefficiencies.

The GST Rate Structure Conundrum

One of the biggest challenges is the multi-slab structure.

Currently, GST has five major rates: 0%, 5%, 12%, 18%, and 28%, in addition to cess on luxury/sin goods like cars, tobacco, and aerated drinks. This complex system has led to:

• Classification disputes (e.g., is a food item a luxury or essential?).

• Distortions in consumption as similar products fall under different slabs.

• Compliance complexity for businesses, especially small and medium enterprises (SMEs).

For instance:

• Nearly 70% of consumption goods and services fall into the 18% slab.

• Items taxed at 28% create anomalies, especially when essential consumer durables face the same rate as luxury cars.

• The five-slab system increases disputes and undermines efficiency.

Economists argue that India should move to a two- or three-slab system:

• A merit rate (5% for essentials),

• A standard rate (12–15%),

• A demerit rate (28% plus cess for luxury/sin goods).

Such rationalization would reduce confusion, improve compliance, and create stability.

The Illusion of the 5% Rate

The 5% rate, often seen as relief for consumers, is in fact a design flaw.

• Input tax credits (ITC) are often restricted or denied for goods taxed at 5%.

• This creates a cascading effect, as taxes paid on inputs cannot be offset.

• As a result, the effective tax burden is higher than 5%, hurting small firms.

For example, textile and footwear industries face this issue, leading to demands for higher uniform rates with full ITC instead of a deceptively low rate.

Input Tax Credit (ITC) and Cascading

The vision of GST was seamless credit flow across the supply chain. In practice:

• ITC restrictions: Many sectors, such as petroleum, electricity, and alcohol, are outside GST, breaking the credit chain.

• Over-reporting of revenue: Collections at the 18% slab are inflated because denied ITCs aren’t deducted.

• Higher compliance costs: SMEs struggle to claim credits due to strict documentation.

Without fixing ITC, GST cannot truly eliminate cascading taxes.

Fiscal Federalism and Centre–State Tensions

GST fundamentally changed India’s federal fiscal structure.

• Earlier System: States had autonomy over sales tax/VAT; Centre controlled excise and service tax.

• Under GST: States ceded significant powers; GST Council was created for joint decision-making.

While cooperative federalism was the intent, problems emerged:

1. Compensation Issue

   • States were promised compensation for 14% annual revenue growth for 5 years (till 2022).

   • COVID-19 strained finances; Centre delayed payments, sparking tensions.

   • States argue GST has reduced their fiscal independence.

2. Revenue Sharing

   • GST is collected into a common pool, then divided.

   • Disputes over formulae often create political conflicts.

3. Decision-Making Gridlock

   • The GST Council requires consensus, but political differences slow reforms.

This has led to a fragile fiscal federalism, raising questions about long-term state autonomy.

The Road Not Taken: Petroleum, Electricity, and Alcohol

A major flaw in GST is the exclusion of petroleum products, electricity, and alcohol—large contributors to state revenues.

• Petroleum: Taxing it under GST would allow ITC credits, reduce cascading, and bring transparency. But states fear revenue loss since petroleum taxes form a large chunk of their earnings.

• Electricity: Currently outside GST, leading to higher costs for industries due to unrecoverable taxes on power.

• Alcohol: Excluded due to political sensitivities, leaving a major economic sector outside the GST framework.

The exclusion of these sectors undermines the vision of GST as a comprehensive consumption tax.

MSMEs and the Compliance Burden

Micro, small, and medium enterprises (MSMEs) form the backbone of India’s economy. Unfortunately, GST has increased their compliance burden:

• Multiple returns: GSTR-1, GSTR-3B, annual returns—all mandatory.

• Technical challenges: Digital filing requires infrastructure many small firms lack.

• Working capital strain: ITC refunds are often delayed, hurting liquidity.

• Composition scheme limitations: Intended for small firms, but restrictive and excludes inter-state trade.

The result is that while large corporates can adapt, MSMEs face structural disadvantages under GST.

Reforms are needed to simplify compliance, ease filing, and provide faster refunds.

Luxury, Sin Goods, and Special Cases

Luxury goods, such as cars, jewellery, and high-end electronics, continue to be taxed at the highest slabs. While justifiable, the system faces issues:

• Unjustified anomalies: Hand-made jewellery or small artisans face higher rates, though not “luxury.”

• Cess complications: Additional cess over the 28% slab makes compliance harder.

• Inflationary effects: High rates can discourage consumption, slowing growth in sectors like real estate and automobiles.

A more rationalized approach is required, balancing revenue needs with sectoral realities.

The Way Forward: Next-Generation GST Reforms

For GST to achieve its full potential, India must implement deep reforms:

1. Move Towards Fewer Slabs

   • Rationalize to 2–3 slabs for simplicity and stability.

2. Full ITC Across Sectors

   • Include petroleum, electricity, and alcohol in GST.

   • Allow seamless ITC credits across the supply chain.

3. Simplify Compliance for MSMEs

   • Fewer returns, user-friendly systems, easier refund mechanisms.

4. Strengthen Federal Balance

   • Ensure timely compensation to states.

   • Create transparent revenue-sharing mechanisms.

5. Improve Governance and Technology

   • Use AI and data analytics to detect fraud, reduce evasion.

   • Build a GST system that aids business growth instead of creating red tape.

Global Best Practices

Countries with GST/VAT systems (e.g., Singapore, Australia, Canada) typically use:

• One or two rates only.

• Minimal exemptions.

• Full ITC flow.

• Strong digital compliance with low burden.

India can learn from these models while adapting to its unique federal structure.

Conclusion

India’s GST journey represents both a remarkable achievement and a continuing challenge. It has successfully unified the market, boosted tax compliance, and modernized the indirect tax system. Yet, its structural flaws—multi-slab rates, denied ITCs, fiscal tensions, and MSME burdens—prevent it from becoming the “perfect GST.”

The time has come for next-generation reforms: a simplified rate structure, seamless credits, broader coverage, and genuine federal cooperation. Only then can GST fulfill its promise of creating a truly efficient, fair, and growth-friendly tax system.

Five Exam-Ready Questions and Answers

Q1: What is the biggest structural challenge in India’s GST system?
A: The multi-slab rate structure (0%, 5%, 12%, 18%, 28% + cess), which creates confusion, compliance complexity, and classification disputes.

Q2: Why is the exclusion of petroleum, electricity, and alcohol from GST problematic?
A: It breaks the input tax credit chain, leads to cascading taxes, and prevents GST from becoming a truly comprehensive consumption tax.

Q3: How has GST affected MSMEs in India?
A: MSMEs face heavy compliance burdens, liquidity issues due to delayed ITC refunds, and difficulties in interstate trade under the composition scheme, creating structural disadvantages compared to large firms.

Q4: What reforms are suggested to make GST more effective?
A: Moving to fewer slabs, allowing full ITC across sectors, simplifying compliance for MSMEs, strengthening Centre–state fiscal balance, and including petroleum/electricity/alcohol under GST.

Q5: What global best practices can India adopt to improve GST?
A: Adopting a single/dual rate system, minimizing exemptions, ensuring seamless ITC, and reducing compliance burden using digital governance.