Representative image depicting GST.
Credit: iStock Photo
Indirect tax, by nature, is complicated. The Centre and state legislations further complicate it in terms of levies and the collection of revenue. India faced this for a long time till the introduction of GST in 2017, which marked a significant change with one national framework to make the process simple. There were four slabs (5%, 12%, 18% and 28%), which created multiple challenges in terms of classifications and implementation. Voices were frequently raised to restructure and make the regime simpler for the people and the administration.
Lower consumption, volatility in the world economy, partially due to multiple wars, jobless growth leading to economic slowdown, etc., called for an overhaul of the framework to make it simpler, fairer, faster, and efficient with the objective of stimulating consumption-led growth. GST 2.0 introduced two slabs (5% and 18%) and a higher slab of 40% for luxury and sin products like pan masala and tobacco products. An elasticity concept in economics would tell that in luxury and sin products, which are highly inelastic in nature, any price increase would not reduce the demand significantly, and hence, the tax revenue would be higher. A higher tax on cigarettes, that is 40%, and a lower tax on bidis would rather see price-sensitive consumers shifting to bidis.
The GST cut on bidis seems to be aimed at protecting the domestic bidi industry that employs over 70 lakh people, predominantly women. However, the 40% slab has raised several concerns. India’s aspiring middle class, especially located in small towns, is increasingly drawn towards luxury products. Higher taxation could discourage consumption and even push consumers to take loans for high-end goods, increasing household debt. This might not be fair to the middle-class population buying luxury products. If the consumption needs to be boosted, these luxury items must be taxed at a rate lower than 40%.
From a macroeconomic perspective, the GST cuts come at a strategic point. India’s private consumption as a percentage of nominal GDP is around 61.4%. The Finance Ministry expects the GST reduction could increase the growth by 0.3-0.5 percentage points in FY 2025-26, and economists predict a stronger spike this year due to this relief. It is consistent with Keynesian Economics – lower taxes will lead to higher disposable income and consumption, which increases aggregate demand due to the consumption multiplier, stimulating production, employment, and overall economic activities.
A higher tax on luxury products would act like a leakage in the multiplier process, and the aspirations of a large middle-class buying luxury products. The current marginal propensity to consume and declining bank credit growth rate (by around 6% from 2024 to 2025) point to a reduction in the demand for non-essential goods and services. This trend indicates households are cutting back on their discretionary spending.
Winners and losers
The demand for agricultural inputs is inelastic in nature; a 7% reduction would provide low to moderate relief, as consumers would purchase similar quantities for their agricultural needs. A similar relief is provided to affordable education items. The cost of healthcare is increasing; with a medical inflation rate of 13%-15% annually, a 7% reduction may not provide any major relief.
The insurance sector received the biggest boost, with a waiver on premiums. This would help the negatively growing industry and the public to purchase multiple policies and attract the price-sensitive customers.
Increasing rates of admission to sports events by 12% is not helping the youth or the Khelo India mission to promote sports. Betting and gaming are addictive in nature and hence highly inelastic. An increase of 12% will not reduce the demand. A 350cc motorcycle is considered a luxury product and hence, a 9% increase will have a moderate impact.
India’s external environment adds urgency to these domestic reforms. The recent 50% tariff on Indian exports has created new headwinds for growth. Many view the GST reforms as an offsetting measure to overcome the shocks. The Chief Economic Advisor views GST 2.0 as part of a broader expansionary policy, alongside repo rate cuts and revised income tax brackets, to counter global shocks and maintain momentum.
While GST 2.0 is a decisive move toward simplification and its probable impact on the consumption and employment generation, it may fall short of its intended goals if structural imbalances persist. The framework could require further fine-tuning to align fiscal objectives with consumer behaviour, elasticities, and macroeconomic realities. As the dust settles, it is becoming clearer that the GST reform story is far from over. Another round of recalibration may well be on the horizon.
(The writers teach at the School of Business and Management, Christ
University, Bengaluru)