India’s GST overhaul has much to write home about but we can’t ignore its fiscal consequences

Eerily with effect from the same date, a sharp rise in fees on certain types of work-visas for entry to the United States snapped in, which will enhance the US government’s non-tax revenue, among other objectives.

India’s GST reform eliminates two levy rates, 12% and 28%, and reassigns those items to the retained rates of 5% and 18%. Most items went downwards; a few like paperboard and higher- valued garments moved up from 12% to 18%. The 3% rate for gold remains, as does the punitive rate of 40% (with the compensation cess folded in). The zero rate remains (different from exemption), and some 5% (or higher) items have moved to zero. Overall, the average rate of levy has been reduced.

Prior to the 1 July 2017 start of GST, a committee chaired by the then chief economic advisor (CEA) Arvind Subramanian recommended an average rate of 15-15.5%. But when I calculated the average of the initial rates actually enacted, it worked out to 13.5%.

My calculation was based on the announced rates, thereby assuming total collection efficiency (i.e. no evasion), and was not adjusted for commerce conducted below the taxable threshold. But it was not an upper bound because it excluded the compensation cess.

Subsequently, there was a round of (haphazard) rate reductions between September and November 2017, accompanying a much-needed simplification of the initial compliance structure. That round, and subsequent dribbles, would have reduced the average rate well below 13.5%, though I did not estimate by how much. But GST revenue has risen steadily post-covid due to impressive improvements in collection efficiency.

The present round of rate reductions will disincentivize evasion. For instance, kitchenware and household articles are down from 12% or 18% to 5%. With that, GST-excluded channels of purchase, commonly offered by smaller retailers, may vanish altogether.

But in some sectors such as pharmaceuticals, fiscal revenue will decline. It was a humane move to shift 36 medicines for life-threatening or chronic conditions from 18% or 5% rates to zero. Other drugs and medicines have gone down from 12% to 5%. Both reductions are welcome and necessary, but revenue will fall because demand for medicines is price inelastic and GST-evaded purchases are not commonly on offer in this sector.

Another rate reduction to be much applauded, which will improve the quality of construction of buildings and roads but at a predictable fiscal cost, is the levy on cement going from 28% to 18%.

Is that what we are seeing, a transition from an earlier GST that was less humane and penalized construction quality but supported the exchequer to one that is better in those respects but leaves the exchequer with a hole? Consumer enthusiasm on launch on 22 September was noteworthy, but may not sustain GST revenues at the level reached in 2024-25.

At present, people are looking more for public goods like effective drainage systems after the tail-end of the monsoon lashed a wide swathe of urban India from Ludhiana, Dehradun and Gurugram to Kolkata (the last at the start of the festival season).

The rural damage was equally severe. Farmers whose produce could not be transported owing to road closures will look for succour. The laid-off workforce in labour-intensive sectors affected by the August round of US tariffs —textiles, gems and jewellery, and shrimp farms—will look for fiscal assistance.

These pressures for additional fiscal expenditures (although the current CEA V. Anantha Nageswaran is optimistic that punitive tariffs will soon be reversed), come at a time when revenue from GST itself will decline, at least this year and most likely next year too.

What is being looked for is a growth dividend from the changed rate structure. There are at least three features which could deliver that. One is the rate reduction on agricultural inputs like tractors, trucks and intermediates to 5% across the board.

Note that unbranded agricultural produce is exempt, not zero rated, which makes GST on agricultural inputs not rebatable. So these rate reductions will reduce the price of unbranded food, either sold directly or as inputs for branded food (levy rates on which have also been reduced). Food carries a weight of 45.9 % in the consumption basket.

Another welcome feature is the rationalization of inverted duty structures.

Best of all, a simplified GST registration scheme is on offer for units with output tax liability on supplies to registered entities not above ₹2.5 lakh per month (at the relevant rate). The implied threshold is beyond the present composition threshold limit, so such entrants can be in the regular channel with access to input tax credit.

A provision for voluntary withdrawal might take care of the fear of post- registration harassment. If it works, this will finally legitimize transactions between small and big businesses, and release the chokehold of GST on small enterprises.

The Reserve Bank of India’s real growth forecast for the year has been upped from 6.5% to 6.8%. Festive good wishes for that forecast.

The author is an economist.