“Every journey to prosperity needs fuel; for India’s development path, GST reform may well be the octane we require.”

Second Gen GST Reforms: The Diwali Gift

Since its inception on July 1, 2017, India’s Goods and Services Tax (GST) has been hailed as one of the most significant tax reforms in the nation’s history. It unified a complex web of central and state indirect taxes into a single, unified tax, embodying the principle of “One Nation, One Tax.” While the GST regime has been largely successful in broadening the tax base, formalizing the economy, and eliminating the cascading effect of taxes, its initial implementation has been riddled with persistent challenges. The PM Modi announced in his Independence Day speech the “next-gen” GST reforms to be implemented by Diwali. This is not merely a political talking point but a critical economic necessity. A closer examination of the system reveals that the existing structure, marked by a multi-slab framework and procedural complexities, has fallen short of its true potential.

Therefore, the need for GST reforms stems from a confluence of factors: to rectify systemic flaws, to simplify compliance for businesses, to reduce the tax burden on consumers, and to foster a more stable and predictable economic environment conducive to sustained growth. This push for reform is deeply connected to the announcement made in this year’s budget which specifies national aspirations of a “Viksit Bharat” where economic policies are designed to enhance the spending power of the nation’s rising middle class and fortify the economy’s resilience against global headwinds. It mentions the reforms as the fuel in the engine of development this announcement is certainly a step in the right direction.

Why the Reforms Are Needed?

India’s GST journey has been a story of both achievement and frustration. While it has streamlined tax administration and brought greater transparency, it has fallen short of its promise of simplicity and efficiency, creating an urgent case for next-generation reforms. For India’s middle class, already grappling with rising living costs, high indirect taxes erode disposable incomes, limiting their spending power; rationalizing GST rates would directly restore consumer confidence and boost demand in an economy where nearly 60% of GDP is driven by private consumption. This is also vital for sectors like textiles, FMCG, automobiles, and real estate that thrive on domestic demand. At the same time, the GST system has weighed heavily on businesses, particularly MSMEs, which remain burdened by multiple filings, e-way bills, and recurring technical glitches—calling for urgent simplification. On the federal front, the compensation cess, initially a safety net for states, has instead created dependency and frequent disputes, straining centre–state fiscal trust. Moreover, India’s exporters and manufacturers face an inflated cost structure due to cascading tax incidences, weakening global competitiveness at a time when resilience against external shocks is paramount. In essence, GST reform is not just a tax correction exercise—it is an economic imperative to empower the middle class, relieve compliance fatigue, strengthen federal balance, and fuel India’s journey to Viksit Bharat through resilient, demand-led growth.

The Problems with the Current System of GST

The existing GST system, despite its transformative nature, is plagued by several problems and concerns that have hindered its full effectiveness. Chief among these is the multi-slab tax structure, which currently includes four main rates: 5%, 12%, 18%, and 28%, in addition to a 0% rate for essential items and a cess on luxury and demerit goods. This multiplicity of rates has led to significant classification disputes and litigation, as businesses and tax authorities frequently argue over which slab a particular product fall into. For instance, classifying a food item as a “snack” versus a “preparation” can have a major tax implication, creating a gray area that is ripe for conflict. The absurdity of this was humorously highlighted in a widely discussed controversy where plain, ready-to-eat popcorn was taxed at 5%, while caramel popcorn, classified as a sugar confectionery, attracted an 18% GST rate. Is a chocolate-coated biscuit a “biscuit” or “confectionery”? Is lassi a “dairy drink” or “beverage”? This kind of fine-grained, seemingly arbitrary distinction not only increases the administrative burden on businesses but also complicates tax compliance, particularly for Small and Medium Enterprises (SMEs) that lack the resources for dedicated tax departments.

Furthermore, the structure has created an inverted duty structure in several sectors, such as textiles and renewable energy. This occurs when the tax rate on raw materials (inputs) is higher than the tax rate on the finished product (output), leading to an accumulation of unutilized Input Tax Credit (ITC) for businesses. This locks up valuable working capital and harms the competitiveness of domestic manufacturers. While the government has provided for refunds in such cases, the process is often slow and cumbersome, further exacerbating the problem.

The Compensation Cess, initially introduced to reimburse states for potential revenue losses post-GST implementation, has become a contentious issue. Its extension beyond the initial five-year period has been a source of fiscal uncertainty for states and a debate on the principles of cooperative federalism. While it was necessary to ensure a smooth transition, its continuation, combined with a lack of transparency in its application, has drawn criticism.

 

 

The Proposed GST 2.0

In response to these pervasive issues, the Indian government has proposed a blueprint for “next-gen” GST reforms, focusing on three core pillars: structural reforms, rate rationalization, and ease of living. The most significant of the proposed changes is the move towards a simpler two-slab tax structure. Under this model, the current 12% and 28% slabs would be largely phased out. Most goods would be classified under two principal rates: a lower rate (likely 5%) for essential or “merit” goods and a standard rate (likely 18%) for most other goods and services. A separate, higher rate of around 40% would be reserved exclusively for luxury and demerit goods like tobacco and pan masala, replacing the complex cess mechanism. This rationalization is expected to drastically reduce classification disputes and simplify the system for both taxpayers and administrators.

Beyond rate rationalization, the proposed reforms aim to enhance the “ease of doing business.” The government plans to introduce automated, pre-filled GST returns, which would significantly reduce the manual effort and potential for errors for businesses. Furthermore, the reforms are expected to streamline the refund process for businesses with inverted duty structures and exporters, ensuring faster and more predictable access to their working capital. The emphasis on technology-driven solutions, including seamless and time-bound registration for businesses, is a clear signal of the government’s intent to build a transparent and efficient tax regime. These procedural reforms are crucial for bolstering industry confidence and encouraging a broader segment of the economy to formalize and become part of the GST ecosystem.

Learning from Global Best Practices

Compared globally, India’s GST looks far more complicated, mainly because it must balance a federal system and protect state revenues. Most advanced economies keep their GST or VAT simple, with one uniform rate. Australia runs a centralized GST at 10% with only a few exemptions, while New Zealand applies a flat 15% and is often praised as the global benchmark. Singapore too has a single 9% GST, among the lowest worldwide. Even Canada, despite being federal like India, operates a simpler dual system where provinces either levy their own tax or merge it with the federal GST into a Harmonized Sales Tax. The lesson from these examples is clear: a broad-based, simpler system with fewer slabs cuts compliance costs, eases administration, and reduces disputes. India’s move toward a two-slab model is a step closer to these best practices, though adapted to its own socio-economic diversity.

Middle-Class Welfare and the Road to Viksit Bharat

The final, and perhaps most crucial, dimension of these reforms is their potential impact on the welfare of the Indian middle class. The existing multi-slab system has often been criticized for its regressive nature, where the middle class often ends up paying a higher effective tax on essential and aspirational goods. As various studies have indicated, while some luxury items saw a reduction in price, daily essentials, and household goods often saw a price increase under the initial GST regime, adversely affecting household budgets. The proposed reforms directly address this concern by rationalizing tax rates on everyday items. Shifting items from the 12% slab to the proposed 5% slab will provide significant relief to the middle class by making a wide range of goods from packaged foods to household durables and certain services like insurance premiums more affordable. Similarly, moving items from the 28% slab (like ACs, cars, and televisions) to the 18% slab will boost consumption and make “aspirational” goods more accessible.

This focus on boosting consumer spending is not accidental; it is a strategic move to fuel India’s economic engine. The Indian economy has shown remarkable resilience in the face of global headwinds, largely because it is driven by robust domestic demand. While many economies are vulnerable to external factors like geopolitical tensions or trade protectionism (such as the threat of tariffs from the US), India’s reliance on its internal market provides a crucial layer of protection. The GST reforms, by increasing the purchasing power of the middle class, will act as a significant demand stimulus, spurring consumption-led growth. This is a vital step in the journey towards becoming a Viksit Bharat, where a strong, self-reliant, and developed economy is built not just on large-scale infrastructure projects but on the financial well-being of every citizen. These reforms are not merely a correction of a flawed tax structure; they are the fuel required to reach the destination of a developed nation. Ultimately, the success of GST 2.0 will be measured not just in terms of revenue collections or formalization but by its ability to improve the quality of life and financial stability for the vast and growing Indian middle class.