By R. Suryamurthy
On September 22, India will roll out the most sweeping reform of the Goods and Services Tax (GST) since its launch eight years ago. The political packaging is clear: cheaper soaps, medicines, and small cars just in time for the festival season. The new regime collapses the 12% and 28% slabs into two core rates of 5% and 18%, with a steep 40% bracket for luxury and sin goods. Nearly all items now fall into the lower slabs, and the government has promised households relief of tens of thousands of crores through lower prices.
But GST 2.0 is not just a consumer story. The deeper test lies in whether this reset can resolve the chronic flaws of India’s indirect tax system—unutilised input tax credits, compliance overload, State–Centre tensions, and the uneven pass-through of tax cuts. Cheaper goods make for strong headlines, but fixing the plumbing of GST is where the credibility of reform will be judged.
At the heart of GST’s design was the promise of seamless input tax credits (ITC). Firms were supposed to offset taxes paid on inputs against those collected on final sales, preventing the cascading of taxes. In practice, companies are often left with stranded credits when input taxes exceed output levies. Refunds are limited to raw materials, while capital goods and services remain excluded.
The new rates make this problem worse. Fast-moving consumer goods, pharmaceuticals, and processed food now attract just 5% GST, but most of their inputs are still taxed at 18%. A pharma company investing in machinery or a textile firm outsourcing processing is left with blocked credits and liquidity stress. A simple calculation makes it clear: inputs worth ₹1,00,000 at 18% GST require ₹18,000 in tax. Selling the final product at ₹1,50,000 with GST at 5% brings in only ₹7,500 in output tax, leaving over ₹10,000 stranded on the books.
These credits may eventually be adjusted, but the lag locks up working capital, forcing smaller firms to borrow just to stay afloat. For an economy where micro and small enterprises are the backbone of jobs, this distortion is not just a technical flaw—it is a structural handicap.
Fixes have been floated: cross-utilisation between central and state GST, tradable credit scrips, or allowing credits against customs duty. But states fear revenue loss if pools are merged, and the Centre remains cautious after years of fake invoicing scandals. Without airtight safeguards, refund expansion risks becoming another fraud channel. Until this is resolved, GST will remain a half-finished reform.
The official revenue cost of GST 2.0 is pegged at under ₹50,000 crore a year. Independent calculations, however, suggest the true loss could be nearly double once adjustments are stripped away. States are expected to shoulder most of the pain.
For poorer states with weaker tax bases, this is no rounding error. It means deeper deficits or cuts in welfare and development spending. The Centre, by contrast, has fallback options: excise duty hikes, dividends from public-sector companies, and record transfers from the Reserve Bank. What is being sold as a nationally unifying reform risks widening fiscal asymmetry between Delhi and the states.
The safety net of GST compensation cess has also been eroded. It now applies only to tobacco, and that too only until pandemic-era loans are cleared. By early next year, even that may vanish. Without a fresh compact, states will increasingly turn to raising their own levies on fuel, liquor, and property. That undermines the very idea of “one nation, one tax.”
The government is betting on a 0.6 percentage point lift in GDP growth over the next year from GST 2.0. The assumption is that cheaper goods will translate into higher demand. But history offers reasons for caution.
Household spending in India depends more on job security, wages, and rural incomes than on marginal tax cuts. Past GST reductions produced only short-lived bumps before inflation and stagnant wages ate into the gains. Rural demand has been weak for several quarters, and it will not revive simply because biscuits or soap are cheaper.
Even in urban markets, the pass-through is not automatic. Companies do not always cut retail prices in line with tax reductions. Some use the opportunity to expand margins instead. If that happens again, GST 2.0 may fatten corporate profits but leave household budgets largely unchanged. The government’s growth gamble could then misfire.
The GST reset has clear implications across industries—some positive, others more complex.
Automobiles: Small cars, motorcycles under 350 cc, and auto parts now attract 18% GST instead of 28%. This could lift sales during the festive season. But larger vehicles remain in the punitive 40% bracket, and weak rural demand continues to weigh on two-wheeler sales.
Pharmaceuticals and healthcare: Essential medicines, diagnostic kits, and medical supplies now face a 5% rate, while life and health insurance premiums are exempt. This should improve affordability for households. Yet input machinery remains taxed at 18%, leaving manufacturers saddled with blocked credits even as consumers benefit.
FMCG: Everyday goods like biscuits, soap, shampoo, and toothpaste have been moved to the 5% slab. This may spur demand, but again, inputs are taxed higher, creating distortions. Companies may enjoy better margins, but the demand surge could be muted without rising incomes.
Textiles: Lower rates on garments and fabrics will help exports, making Indian products more competitive. But tariff battles abroad, especially with the U.S., limit how far tax relief alone can carry the sector.
Cement and housing: GST cuts are expected to lower input costs in construction, potentially boosting affordable housing. Cement production has already seen growth this year. But the sector is capital intensive, and unrecoverable credits on machinery blunt the benefits.
Banking and insurance: Exempting insurance premiums and reducing taxes on office infrastructure cut costs for banks and insurers. This improves profitability and may encourage broader coverage in health and life insurance. But the fiscal cost of lost tax revenue in this sector is significant, raising questions of sustainability.
Taken together, GST 2.0 offers targeted relief but leaves many of the structural distortions untouched. Gains are uneven, temporary, and often more beneficial to companies than to consumers.
Much of the political narrative rests on the inflation dividend. Forecasts suggest headline CPI could fall by 50–75 basis points, taking inflation close to 3%. But this is far from assured. If companies retain part of the tax cut, the decline will be smaller.
Meanwhile, the fiscal arithmetic is fragile. Even if the Centre meets its deficit target, states are left with weakened revenues just as welfare spending pressures mount. At the same time, global trade shocks—especially high U.S. tariffs on Indian exports—mean India cannot rely on external demand to bail out domestic weakness. GST 2.0 is effectively a bet on consumption. If households do not spend more, both fiscal and growth projections risk coming apart.
Beyond the rates, GST continues to impose heavy compliance burdens. Multiple return filings, complex reconciliation, and delayed refunds remain the lived reality for small firms. Service-sector companies, still taxed at 18%, have gained little.
The GST Appellate Tribunal, promised since 2017, is only now being operationalised. Until it becomes functional, disputes will continue clogging high courts, delaying justice and adding costs. The promise of “ease of doing business” remains more slogan than reality.
GST 2.0 has been marketed as the long-awaited dawn of a “good and simple tax.” It does simplify slabs and provide visible consumer relief. But the structural irritants remain. Unutilised credits, fiscal imbalances, uneven pass-through, and compliance overload still define the system.
The September 22 rollout is progress, but also political theatre. The timing—just before the festival season and amid global tariff shocks—suggests a strong dose of populism. The real reform lies not in announcing cheaper goods but in fixing the distortions that prevent GST from functioning as a seamless, national tax. Until then, GST will remain less a growth engine than a patchwork—one that masks costlier questions beneath its consumer-friendly sheen. (IPA Service)
