GST reforms: Promised boom or risky gamble with revenue shortfalls?

The recent GST reforms in India, heralded by Finance Minister Nirmala Sitharaman as a catalyst for demand, investment, and job creation, have generated considerable buzz. Announced amid efforts to revamp the Goods and Services Tax system into a streamlined two-slab structure—eliminating the 28% and 12% brackets—these changes promise to ignite a virtuous cycle of economic activity. Yet, a closer examination reveals grounds for scepticism.

While proponents argue that lower rates on essentials will boost consumption and address fiscal deficits, the reforms risk exacerbating revenue shortfalls, entrenching inequalities, and falling short of their ambitious goals due to entrenched implementation challenges.

Projected revenue losses and fiscal strain caused by GST reforms

At the heart of the scepticism lies the projected revenue impact. An SBI research report estimates a ₹3,700 crore loss to the government from these rate adjustments, a figure that, while described as minimal by some, could strain an already pressured fiscal framework.

With India's fiscal deficit targeted at 4.4% for the current year, any dip in GST collections—already volatile due to economic slowdowns—might force compensatory measures, such as increased borrowing or cuts in public spending. Critics point out that while the reforms exempt dairy products like paneer and chhena, and reduce rates on items from packaged foods to air conditioners, the benefits may not trickle down uniformly.

For instance, the introduction of a 40% de-merit rate on luxury goods could inadvertently hike prices for aspirational consumers, potentially dampening the very demand the government seeks to stimulate.

Historical precedents and implementation challenges

Historical precedents fuel this doubt. Since its inception in 2017, GST has been plagued by issues such as classification disputes—debates over whether a chocolate-coated biscuit falls under 18% or 28% tax—and an inverted duty structure that burdens manufacturers with higher input costs than outputs.

The latest reforms, dubbed GST 2.0, attempt to address these by simplifying slabs to 5%, 18%, and 40%, but sceptics argue that such changes arrive too late to reverse entrenched inefficiencies. As noted in editorials, the GST Council, a federal body, could have acted sooner, as states had been pushing for reforms years ago.

Delayed refunds and compliance burdens have already eroded trust among small businesses, and the new system may require recalibration of trade promotions and schemes, leading to short-term disruptions for distributors who might demand credit adjustments for inventory bought at higher rates.

Overstated economic stimulus and uneven benefits

Moreover, the economic stimulus narrative appears overstated. While Crisil projects a 6-7% revenue rise for Indian companies in 2025-26 due to lower taxes, this optimism hinges on assumptions of immediate consumption spikes. In reality, if these reforms primarily benefit larger corporations through eased compliance, smaller enterprises—still grappling with the fallout from demonetisation and the pandemic—might see marginal gains at best.

The GTRI's warning of a likely $36 billion drop in US exports if global trade tensions escalate (though not directly linked, it underscores broader vulnerabilities) highlights how domestic reforms operate in a volatile international context.

Domestically, inflation concerns persist; reduced rates on essentials like dairy could temporarily ease household budgets, but if revenue shortfalls lead to compensatory taxes elsewhere, the net effect might be neutral or negative for the average citizen.

Behavioural nudges and regressive outcomes

Behavioural nudges embedded in the reforms—such as taxing sin goods at higher rates to discourage consumption—also invite scrutiny. Proponents claim this promotes fairness, but it risks regressive outcomes, disproportionately affecting lower-income groups who consume certain packaged foods or tobacco products. The shift from multiple slabs to a trio of rates simplifies administration.

Yet, it does little to resolve deeper structural issues like inter-state disparities in GST collections, where wealthier states benefit more from compensation mechanisms. 

Environmental and social critiques add another layer; exemptions for certain agricultural inputs might encourage overproduction, straining resources in a climate-vulnerable nation.

Long-term reflections and policy recommendations

In essence, while the reforms address long-standing complaints about complexity, their positive outcomes remain speculative. The government's narrative of a demand-investment-job cycle sounds appealing, but without robust monitoring and adjustments, these changes could widen fiscal gaps and perpetuate inequalities. 

As India navigates post-pandemic recovery, GST 2.0 might prove a step forward, but only if implementation avoids the pitfalls that marred its predecessor. Policymakers must prioritise transparency and stakeholder consultations to mitigate these risks, lest the reforms become another chapter in India's history of ambitious but underwhelming tax overhauls.