India’s GST Reforms: Balancing Simplification, Growth, and Self-Reliance

As India enters its 80th year of independence, its Goods and Services Tax (GST) regime is set for significant reform. Introduced in 2017, the GST subsumed multiple indirect taxes, including VAT, service tax, and central sales tax, to facilitate better enforcement and ease of compliance. The system currently has four tiers of 5, 12, 18, and 28 per cent, with merit and essential goods taxed at lower rates while demerit and luxury goods face the highest slab. The 18% rate yields the most revenue, accounting for 65% of collection. The 28% tier contributes 11%, while the 12 and 5 per cent brackets have the lowest contributions at 5% and 7% respectively. This multi-tiered structure has limited GST’s ability to streamline India’s tax regime and advance ease of doing business. The finance ministry has announced reforms to the current system, reportedly moving towards two main rates of 5% for essential goods and 18% for most others. However, a much higher 40% tax rate is likely to be levied on demerit goods and services, such as cigarettes and gambling. Gross GST revenues have followed an upward trend, with approximately US$ 129.7 billion collected in 2020-21 and US$ 252.0 billion collected in 2024-25, an increase of roughly 94.3%.

Tax reforms impact a wide range of stakeholders, including major multinational companies and international investors. Given India’s vast domestic market, consumers remain the most important economic stakeholders set to benefit from falling indirect tax rates. This will significantly boost the government’s push for economic self-reliance in today’s dynamic and uncertain global economy, making domestic consumption-led growth the optimal strategy. The proposed reforms focused on structural fixes, rate rationalization, and ease of compliance will potentially boost consumption, enhance manufacturing competitiveness, and signal policy stability to global investors. Yet, their success will hinge on overcoming Centre–state fiscal tensions, maintaining tax neutrality, and ensuring transparency.

Key Reforms

The proposed GST regime is based on three pillars, including structural reforms, rate rationalization, and ease of living.

Pillar 1: Structural Reforms

Structural reforms aim to correct inverted duty structures, resolve classification issues, and promote stability and predictability.

Inverted duty structures arise when tax rates on production inputs (raw materials) are higher than on outputs (finished goods). In such cases, manufacturers can claim tax refunds through Unitized Input Tax Credit (ITC). However, these refunds are currently time-consuming to file, resulting in the accumulation of ITCs in MSMEs, blocking their already limited cash flows. Textiles, footwear, and electronic components are examples of few sectors commonly suffering from inverted duty structures in India. The reforms aim to align taxes on industrial inputs and outputs more closely to limit this credit accumulation and boost domestic value addition in manufacturing.

Classification issues often result in confusion regarding the applicability of GST’s multiple tiers on specific goods and services. This pressurizes businesses to allocate more resources on branding, compliance, and nomenclature in order to secure the most favorable tax rate for their products. Transitioning to a two-rate system will streamline tax compliance and limit ambiguity to foster policy certainty.

Long-term clarity on rates and rules will allow businesses to make investment and pricing decisions with greater confidence, proliferating stability and predictability. This aligns with OECD’s guidelines on tax neutrality, which emphasize that tax systems should not distort or influence economic decisions.

Pillar 2: Rate Rationalization

Rate rationalization is premised on reducing tax rates on everyday essentials and aspirational goods and creating fiscal space by ending compensation cess.

Lowering tax on everyday essentials and aspirational goods will significantly boost consumption in Indian markets, particularly by middle-income households. Domestic consumption currently accounts for nearly 60% of India’s GDP. Tax reductions will further stimulate demand, aligning with Prime Minister Modi’s push for consuming made in India products. This will bolster India’s macroeconomic stability, insulating its producers’ from the widespread uncertainties of global markets. Ultimately, it will empower the country to leverage its mammoth domestic market and reaffirm organic, demand-driven growth.

Ending the GST compensation cess, once used to protect state revenues and repay COVID-era borrowings, frees up revenue that was previously earmarked, giving the government more flexibility to lower GST rates without straining fiscal stability. However, without this safety net, states may be vulnerable to potential short-term revenue losses, making consensus-building crucial for reform.

Pillar 3: East of Living

The third pillar focuses on making GST administration more efficient, particularly for small businesses and exporters.

The reforms aim to streamline GST registration processes for small businesses and leverage digital infrastructure to boost compliance. Further, they aim to reduce refund times for export-oriented manufacturers suffering from inverted duty structures. The World Bank currently ranks India 63rd in its global ease of doing business index, and these measures could help propel the country closer to the top.

Why Now?

India’s proposed GST reforms must be viewed within today’s volatile global economic context. Uncertainty in markets, particularly from US President Trump’s tariffs on India over Russian oil imports, has dampened business confidence. Moreover, while India has sustained a commendable growth trajectory, global headwinds make it vulnerable to capital flow reversals and shifting international alliances amid the transactional nature of contemporary world politics. Net FDI inflows, for example, have exhibited sharp declines in recent years, making up only 0.7% of GDP in 2024 compared to 1.5% in 2022. While this slowdown may not directly reflect concerns regarding India’s economic fundamentals, the volatile global economy is encouraging profit-booking in emerging markets and reallocation of capital in ‘safe haven’ assets.

Given these developments, India must bolster its consumer spending to preserve it as a stable and reliable pillar of economic growth. Proactive foreign policy, especially securing oil imports from Russia, has helped contain inflation and maintain lower interest rates. Looking ahead, a growing population and improving standards of living will sustain growth in the country’s consumer market. Deloitte’s India outlook report projects that by 2030, the nation is will add around 75 million middle-income households, significantly expanding the domestic base. Simplifying the tax structure will enable businesses across the country leverage this consumer growth, ultimately boosting employment and overall investment. Limiting inverted duty structures will be key to supporting MSMEs in this growing market, bolstering supply chains and empowering export-oriented manufacturers to deepen integration in global value chains.

Risks and Challenges

While the proposed GST reforms promise simplification and growth, their implementation faces risks that stem from political and fiscal constraints.

Friction between Centre and State Governments: GST is governed by the principle of cooperative federalism, with both the central government and states sharing powers through the GST Council. Any change in rates or structure requires consensus, which can be difficult to achieve. Moreover, GST revenues are shared equally between the central and state governments. Hence, states heavily reliant on GST revenues may resist reforms that reduce their collections. Further, they may demand strong guarantees that reforms will not undermine their fiscal health.

Potential revenue dips in the short-term: while the reforms aim to boost compliance in the long-term, GST reductions on essential and aspirational goods may reduce government revenues in the immediate future. While not the sole source of revenue, tax collection plays a critical role in supporting India’s government spending. In 2023–24, about 27.6% of India’s gross tax revenues came from the GST, making it an essential contributor to the country’s macroeconomic stability.

Transitional support for small businesses: the prevalence of misinformation and disinformation in media channels risks creating uncertainty regarding new tax structures. MSMEs with low compliance budgets and lack of expertise are particularly vulnerable to administrative backlogs and may not be able to adapt quickly to reformed systems. Thus, the government must supplement structural changes with proactive stakeholder engagement to ensure last mile delivery of its “ease of living” agenda. Transparent communication regarding policies on tax refunds and digitalized registration will be key to determining the success of the proposed tax reforms.

Conclusion

The proposed GST reforms represent more than a technical adjustment to tax rates and are a strategic attempt to align fiscal policy with India’s broader developmental trajectory. By addressing inverted duty structures, rationalizing multiple slabs, and streamlining compliance, the reforms aim to boost household consumption, strengthen domestic manufacturing, and catalyze India’s pursuit of self-reliance. Their success, however, will depend on strategic political management, particularly in securing state cooperation. If implemented effectively, these reforms could make GST a more growth-oriented tax regime, placing India closer to global best practices while preserving fiscal stability. In a volatile international environment marked by shifting capital flows and geopolitical uncertainty, a simplified and consumption-friendly GST can help the country harness its vast domestic market as a reliable engine of growth. Ultimately, it would signal to the world that India is committed to developing a high-growth economic system fit for today’s competitive globalized environment.

Ishan Jasuja is a fellow of the 16th Council.