Context

The Goods and Services Tax (GST) was originally introduced to establish a destination-based tax regime, aimed at enhancing efficiency by placing the tax burden on final consumption and allowing for input tax credits. Despite its transformational goal, the initial GST framework was hindered by multiple tax slabs, inverted duty structures, and high compliance burdens. The revised GST rate structure, effective from September 22, 2025, marks a major overhaul with significant implications for consumption, production, fiscal revenue, and macroeconomic equilibrium.

Evolution of the New GST Structure and Revenue Implications

·       The 2025 reforms eliminated the 12% and 28% tax slabs, consolidating most goods and services into 0%, 5%, and 18% brackets, while introducing a 40% rate on luxury and sin goods. Concessional rates below 5% were retained for certain essential items. These revisions are particularly favourable to employment-rich sectors like textiles, automobiles, healthcare, consumer electronics, and food products. On the production front, industries tied to agriculture, fertilisers, machinery, and renewable energy benefit from lower input costs.

·       Out of 546 items subjected to rate revision, nearly 80% witnessed reductions—signalling a clear orientation toward boosting consumption and growth. However, the fiscal implications of such reductions are considerable. The basic formula for GST revenue (R = r × E), where r represents the tax rate and E the tax base (dependent on pre-tax prices and quantities), shows that although lower post-tax prices may stimulate demand, the resultant increase in consumption does not proportionally offset the drop in tax rates. Consequently, revenue generally declines. In the case of zero-rated items, revenues are entirely nullified. Even for items moved to the 40% slab, any perceived increase in tax collection largely reflects the consolidation of compensation cess rather than a genuine rate hike.

·       Revenue loss projections vary: while the Ministry of Finance estimates an annual shortfall of ₹48,000 crore, independent assessments point to potentially higher figures.

Shortcomings of the GST Reform

·       One of the core outcomes of the reform is the redistribution of economic benefits in favour of consumers. Reduced GST translates into increased disposable income, especially for individuals purchasing goods in the 5% bracket—mostly basic necessities. Given the low elasticity of demand for such goods, consumers are likely to reallocate their surplus income toward higher-taxed categories, such as comforts and luxuries in the 18% and 40% brackets. This could, over time, increase tax revenues. However, in the immediate term, the fiscal impact remains adverse due to the disproportionate shortfall.

·       In terms of structural efficiency, the revised GST system does not fully eliminate tax cascading. Exempted goods still disallow input tax credit (ITC), embedding upstream taxes into final prices. Even within the 5% bracket, where inputs are taxed at 18%, the process of claiming ITC is cumbersome and prone to delays. These inefficiencies reduce the reform''s potential to rationalise resource allocation and enhance overall competitiveness.

·       From a macroeconomic standpoint, the reforms intersect with broader fiscal concerns. In the first quarter of FY 2025-26, nominal GDP growth stood at 8.8%, falling short of the 10.1% target set in the Union Budget. With inflation remaining subdued, tax buoyancy has diminished. Compounding the issue, direct tax revenues declined by 4.3% during the early months of the fiscal year—contrasting sharply with prior trends of robust growth. The budget had already accounted for a ₹1 lakh crore shortfall due to changes in personal income tax. Additional revenue losses from GST could push total gross tax receipts significantly below projections.

·       Although higher dividends from the Reserve Bank of India might provide partial relief, the government is likely to face a trade-off between reducing expenditure and widening the fiscal deficit. States are similarly constrained and may resort to borrowing or budget cuts—both of which pose risks to growth. On the monetary front, interventions such as repo rate cuts or liquidity infusions could stoke inflation or even lead to deficit monetisation, a risky and unsustainable path.

Growth Prospects and Structural Limits

While reduced GST rates might temporarily uplift demand, this alone cannot secure sustainable long-term economic growth. India’s medium-term growth prospects hinge more on its investment and savings rates, along with improvements in capital efficiency, measured by the incremental capital-output ratio. Thus, even though GST reforms may deliver immediate benefits to consumers and production-oriented sectors, they cannot substitute for deeper structural changes that improve investment capacity and productivity.

Conclusion

The 2025 GST reforms constitute a bold attempt to simplify India’s complex tax architecture and stimulate economic activity. They promise reduced prices, enhanced purchasing power, and sector-specific advantages, particularly for labour-intensive industries. However, these gains come at a substantial fiscal cost, with immediate revenue losses threatening the stability of both central and state budgets. In addition, unresolved inefficiencies—such as cascading taxes and ITC challenges—continue to hinder the system''s effectiveness. Ultimately, while the revised GST framework may serve as a complementary mechanism for economic stimulus, it cannot replace comprehensive strategies aimed at boosting savings, investment, and long-term productivity.