Required Reforms in GST, Balancing Revenue Loss with Economic Growth

Required Reforms in GST, Balancing Revenue Loss with Economic Growth

Why in News?

The central government has recently proposed significant reforms in the Goods and Services Tax (GST) framework. These reforms include slashing tax rates across slabs, simplifying procedures for registration, return filing, and refunds, and rationalizing the overall GST structure. If implemented, these reforms will substantially reduce the tax burden on consumers and businesses. However, they also raise concerns about potential revenue loss for both the Centre and the States.

Introduction

The Goods and Services Tax (GST), introduced in July 2017, was one of the most ambitious indirect tax reforms in India’s history. It aimed to replace multiple cascading taxes levied by the Centre and the States with a unified tax system, thereby promoting ease of doing business, reducing tax complexities, and widening the tax base.

Over the years, however, multiple issues have arisen within the GST framework. These include too many tax slabs, complex compliance requirements, and frequent litigation due to ambiguities in classification. Recognizing these challenges, the central government has now proposed bold reforms to streamline GST.

Among the most notable proposals are:

1. Shifting 99% of items currently under the 12% slab to the 5% slab.

2. Reducing the burden of items in the 28% slab by moving 90% of them to the 18% slab.

3. Rationalizing slabs to reduce ambiguities and disputes.

4. Simplifying GST procedures for registration, return filing, and refunds.

While these reforms promise relief to consumers and businesses, they also raise concerns about revenue shortfalls, which could affect fiscal stability and State finances.

Key Issues and Institutional Concerns

1. Tax Rate Rationalization

Currently, India has multiple GST slabs—0%, 5%, 12%, 18%, and 28%. The government’s proposal to merge most items from 12% to 5% and from 28% to 18% would reduce the multiplicity of rates, making GST simpler and more business-friendly. This rationalization will lower consumer costs, enhance purchasing power, and encourage higher consumption.

However, this move will also reduce government revenue in the short term. According to past estimates by the Reserve Bank of India (RBI), India’s average GST rate was 11.6%, which is now expected to fall substantially if reforms are implemented. This could significantly impact government finances, particularly at a time when fiscal demands are high.

2. Procedural Reforms

Another crucial area of reform lies in simplifying GST procedures. Currently, taxpayers often complain about complex registration processes, frequent compliance deadlines, and delays in refunds. The proposed reforms aim to:

• Ease registration requirements.

• Simplify return filing.

• Speed up refunds.

These steps are expected to reduce the compliance burden, especially for small and medium businesses (SMEs), which form the backbone of India’s economy.

3. Revenue Concerns and State Finances

While reducing tax slabs will boost consumption, it could cause a revenue loss for both the Centre and States. With many items being taxed at only 5%, there is a fear that States’ share of revenue will decline.

States are already lobbying the Sixteenth Finance Commission to increase their share in central taxes. Moreover, the possibility of including petroleum products under GST seems even less likely, given States’ heavy dependence on petroleum revenue.

The Centre has promised to reach out to States and take their concerns into account, but managing this political and fiscal tension will be a major challenge.

4. Risks of Tax Evasion and Fraud

GST has often been criticized for loopholes that allow input tax credit (ITC) frauds. With lower rates, the incentive for such frauds reduces, but effective monitoring mechanisms are still needed to prevent tax evasion.

Challenges and the Way Forward

1. Revenue Shortfall

A major challenge for the government is balancing lower tax rates with fiscal stability. Even though higher consumption and a wider tax base are expected to offset the loss, this outcome depends on strong demand growth and better compliance.

2. State-Level Resistance

States may not directly oppose the reforms but are likely to demand compensation from the Centre. Past experiences during the GST compensation period (2017–2022) show how contentious Centre-State fiscal relations can become.

3. Petroleum Products Exclusion

States depend heavily on petroleum taxes for revenue. Since GST rate cuts reduce fiscal space, the inclusion of petroleum in GST—which has been a long-standing demand from businesses—remains unlikely in the near future.

4. Ensuring Ease of Doing Business

The effectiveness of reforms will depend not only on tax rate rationalization but also on real improvements in compliance mechanisms. Faster refunds, simpler returns, and fewer litigations are necessary to make GST genuinely business-friendly.

Economic Implications

1. Boost to Consumption: Lower tax rates will leave more disposable income with consumers, increasing demand for goods and services.

2. Support to Businesses: SMEs and the middle class will particularly benefit from reduced rates and simplified compliance.

3. Long-Term Gains: Over time, increased consumption and a broader tax base may compensate for the initial revenue loss.

4. Risks of Fiscal Stress: In the short term, however, both the Centre and States may face budgetary pressures, especially when public spending needs are rising.

5. Global Trade Concerns: The reforms come at a time when export demand is weakening due to tariff uncertainties. By boosting domestic demand, India can partly offset external economic pressures.

Conclusion

The government’s proposal to reform GST is both ambitious and risky. On one hand, it simplifies tax structures, reduces consumer burden, and encourages higher domestic consumption. On the other, it creates fiscal challenges by reducing revenues and straining Centre-State relations.

If implemented effectively, 2025 could mark a watershed year for tax reform in India. The combination of GST rationalization, new income-tax reforms, and procedural simplifications has the potential to make India’s tax system more efficient, transparent, and business-friendly. However, the Centre must carefully negotiate with States, monitor revenue collections, and ensure that procedural bottlenecks are genuinely removed. Only then can these reforms achieve their intended goal of boosting growth while maintaining fiscal discipline.

Q&A Section

Q1. What are the key proposals in the government’s GST reform plan?
The main proposals include shifting 99% of items in the 12% slab to 5%, reducing 90% of items in the 28% slab to 18%, rationalizing GST slabs, and simplifying compliance processes such as registration, return filing, and refunds.

Q2. How will these reforms impact consumers and businesses?
Consumers will benefit from lower prices as the tax burden reduces. Businesses, particularly SMEs, will find compliance easier due to simplified registration and return filing processes.

Q3. What challenges might arise from reducing GST rates?
The primary challenge is revenue loss for both the Centre and States. This may lead to fiscal stress, with States likely demanding higher compensation from the Centre.

Q4. Why are States concerned about the GST reforms?
States fear losing revenue due to lower tax rates. They also worry that their dependence on petroleum revenues will increase, as the inclusion of petroleum in GST seems unlikely in the near future.

Q5. How could the government balance revenue loss with economic growth?
The government hopes that increased consumption and a broader tax base will offset revenue losses. Additionally, improved compliance, reduced fraud, and higher economic activity may help restore fiscal balance in the medium term.