GST: An Unfinished Fiscal Reform

 

Why in the News?

1. In July 2025, the eighth anniversary of the Goods and Services Tax (GST) in India was observed, coinciding with one of the poorest GST collection months.
2. GST collections for June 2025 stood at ₹1.85 lakh crore, the lowest in four months, highlighting serious concerns about the health of India’s indirect tax system.
3. The slowdown in collections has reignited the demand for structural reforms in the GST regime, including rate rationalisation and expansion of the tax base.

Key Highlights

1. Sluggish Growth in GST Collections
   1. The collections in June 2025 were only 6.2% higher than June 2024, marking the slowest annual growth in four years.
   2. Once refunds were accounted for, the net revenue growth stood at a mere 3.3%.
   3. This trend reflects stagnation in both consumption and revenue mobilisation.
2. Weakness in Domestic Economic Activity
   1. Revenue from domestic transactions (excluding imports) grew by only 4.6% year-on-year.
   2. This growth barely exceeded the average inflation rate, indicating almost no real growth in domestic consumption.
   3. This shows that the economy's internal demand is still weak, despite headline growth figures.
3. Structural Shortcomings in GST System
   1. A drop in GST collections also points to deep-rooted inefficiencies in the tax system, beyond just economic cycles.
   2. Despite eight years since implementation, GST still suffers from a complex rate structure and a limited tax base.
   3. Commonly used items like fuel and alcohol remain outside the GST ambit due to state resistance.
4. States’ Reluctance to Broaden the GST Base
   1. States are unwilling to bring fuels and alcohol under GST, as they are major independent revenue sources.
   2. There is resistance to reforms that may reduce states' fiscal autonomy.
   3. This has created a persistent Centre-State trust deficit, affecting cooperative federalism.
5. Issues Surrounding Cess and Rate Structure
   1. The GST Compensation Cess, originally introduced to cover short-term state revenue losses, has been extended until 2026.
   2. With its initial purpose fulfilled, the continued imposition of this cess raises questions.
   3. The Centre must resist the temptation to merge this cess into the broader GST, as it undermines transparency and trust.

About Goods and Services Tax (GST)

1. Introduction to GST
   1. GST is a comprehensive, multi-stage, destination-based indirect tax levied on the supply of goods and services.
   2. It replaces a complex web of central and state indirect taxes and aims to create a unified national market.
   3. Though collected at each stage of value addition, it allows for full input tax credit, ensuring tax is ultimately borne by the final consumer.
2. Historical Evolution of GST
   1. 2003: Kelkar Task Force recommends VAT-based taxation.
   2. 2006: Union Budget announces intention to implement GST by April 2010.
   3. 2014: Introduction of the 122nd Constitutional Amendment Bill.
   4. 2016: Passage of the Bill as the 101st Constitutional Amendment Act.
   5. 1st July 2017: Formal launch of GST across India.
3. Constitutional and Legal Framework
   1. Article 246A: Empowers both Parliament and State Legislatures to legislate on GST.
   2. Article 269A: Governs the levy and distribution of Integrated GST (IGST).
   3. Article 279A: Establishes the GST Council.
   4. GST laws passed in 2017:
      1. Central GST (CGST) Act: Governs levy and collection of GST by the Central Government on intra-state supplies.
      2. State GST (SGST) Act: Enacted by each State to govern levy and collection of GST by the respective State Government on intra-state supplies.
      3. Union Territory GST (UTGST) Act: Applies to Union Territories without legislatures (e.g., Chandigarh, Lakshadweep), enabling them to collect GST.
      4. Integrated GST (IGST) Act: Governs GST on inter-state supplies of goods and services, imports and exports, collected by the Centre and shared.
      5. GST (Compensation to States) Act: Provides for compensation to States for revenue losses arising from GST implementation, funded by Compensation Cess.
4. Key Features of GST
   1. Dual GST Model: Centre and States levy CGST & SGST on intra-state supplies; IGST on inter-state supplies.
   2. Destination-Based Tax: Tax is collected by the state where the goods/services are consumed.
   3. Supply-Based Taxation: GST is levied on “supply” instead of manufacture, sale, or provision.
   4. Input Tax Credit (ITC): Eliminates cascading effect ( by crediting taxes paid at earlier stages.
      1. Cascading effect refers to “tax on tax” that is, when tax is levied on a product at every stage of the supply chain without credit for the tax paid at the earlier stage.
   5. Online Compliance: All registrations, payments, and returns are filed through the GSTN portal.
   6. Threshold Limits:
      1. Threshold limit is the minimum turnover below which a business is not required to register under GST.
      2. It implies that small businesses are exempt from GST compliance to reduce their burden.
      3. The limit is:
         1. ₹40 lakh for goods suppliers (₹20 lakh for special category states).
         2. ₹20 lakh for service providers (₹10 lakh for special category states).
5. Components of GST
   1. CGST: Collected by the Centre on intra-state transactions.
   2. SGST/UTGST: Collected by the State/UT on intra-state transactions.
   3. IGST: Collected by the Centre on inter-state and import/export transactions and distributed accordingly.
6. Taxes Subsumed Under GST
   1. Central Taxes
      1. Central Excise Duty, Service Tax, Additional Duties of Customs (CVD & SAD), Central Sales Tax, surcharges, and cesses.
   2. State Taxes:
      1. VAT, Entry Tax, Luxury Tax, Entertainment Tax, Purchase Tax, State Cesses & Surcharges.
   3. Excluded from GST:
      1. Alcohol for human consumption, petroleum products (until future decision), electricity duty, stamp duty, and vehicle tax.
7. Tax Rate Structure
   1. Multiple Tax Slabs: 0%, 5%, 12%, 18%, and 28%.
   2. Special Rates:
      1. 0.25% on precious stones, 3% on gold, 1.5% on affordable housing, etc.
   3. Compensation Cess: Levied over the 28% slab for specific luxury and sin goods.
8. GST Compensation Cess
   1. Introduced to compensate States for revenue loss due to GST implementation.
   2. Guaranteed 14% annual revenue growth over 2015–16 levels for 5 years (till June 2022).
   3. Levied on goods like tobacco, pan masala, coal, aerated drinks, and luxury vehicles.
   4. Proceeds go into the GST Compensation Fund.
   5. Extended till March 2026 to repay pandemic-time borrowings.
   6. Criticism:
      1. Centre controls cess proceeds (not shared), creating Centre-State trust issues.
      2. Its extension beyond original scope raises cooperative federalism concerns.
9. GST Council
   1. Constitutional body under Article 279A.
   2. Chairperson: Union Finance Minister.
   3. Members: Ministers of Finance/Taxation from each state/UT.
   4. Decision Voting:
      1. Centre: 1/3rd weight
      2. States: 2/3rd combined
      3. Decisions need 75% approval.
10. GST Network (GSTN)
    1. IT backbone for GST implementation.
    2. A non-profit company managing registration, returns, payments, refunds.
    3. Shareholding: Centre 24.5%, States 24.5%, Private stakeholders 51%.
11. Compliance and Processes
    1. Invoice Matching and e-Invoicing to reduce fraud.
    2. E-Way Bill for goods transport > ₹50,000.
    3. Quarterly Return Filing and Monthly Payment Scheme (QRMP) Scheme for quarterly returns by small taxpayers (turnover < ₹5 crore).
    4. Reverse Charge Mechanism (RCM): Liability to pay tax rests with the recipient, not supplier.
12. Benefits of GST
    1. Unified National Market: Removal of inter-state barriers.
    2. Ease of Doing Business: Uniform rates and seamless Input Tax Credit (ITC).
    3. Transparency: Reduced corruption and tax evasion through digital trail.
    4. Formalisation of Economy: Encourages businesses to come into the tax net.
13. Challenges in GST Implementation
    1. Exclusion of Key Items: Petroleum and alcohol remain outside GST scope.
    2. Complex Rate Structure: Multiple slabs, exemptions, and cess lead to classification disputes.
    3. Inverted Duty Structure: It occurs when GST on inputs is higher than GST on final products. This leads to accumulation of ITC, which businesses must claim as refunds.
       1. Example: GST on raw material = 18%; GST on finished product = 12%.
       2. Results in working capital blockages, refund delays, and compliance burdens.
    4. Compliance Burden: High frequency of returns, portal glitches, and lack of awareness.
    5. Federal Tensions: Revenue shortfalls and compensation issues have strained Centre-State relations.
14. GST Reforms and GST 2.0
    1. Public Accounts Committee (PAC) Recommendations:
       1. Shift to GST 2.0 for better state autonomy.
       2. Real-time monitoring, biometric verification, and audit integration.
    2. State Empowerment Proposals:
       1. Assign entire GST revenue or petroleum excise to States for greater fiscal space.
    3. Way Forward:
       1. Rationalise tax slabs.
       2. Include petroleum and alcohol in GST.
       3. Strengthen GST Council decision-making and dispute resolution.

Impact on Indian Economy

1. Decline in Consumer Demand and Economic Activity
   1. GST is a consumption-based tax, and low collections signal declining consumer spending.
   2. This decline, especially in urban areas, can dampen overall economic momentum.
   3. It reflects underwhelming post-pandemic recovery in sectors like retail and services.
2. Stress on Fiscal Federalism and State Finances
   1. States are under pressure due to declining tax shares and limited revenue options outside GST.
   2. Continued dependence on cess, which is not shared with states, has widened the Centre-State trust gap.
   3. This can hinder efficient implementation of welfare and development schemes at the state level.
3. Delay in Achieving the Original GST Vision
   1. The idea of “one nation, one tax” remains partially fulfilled as important items like fuel remain outside GST.
   2. Multiple tax slabs and exemptions continue to complicate compliance.
   3. Public perception of GST as a burdensome and incomplete reform is growing.
4. Reduced Fiscal Space and Spending Ability
   1. Slower tax collection reduces the government's ability to finance development and welfare programmes.
   2. This may lead to higher borrowing, expenditure cuts, or reallocation from essential sectors.
   3. It also affects the fiscal deficit and long-term economic sustainability.
5. Taxpayer Confusion and Lower Compliance
   1. A complex and inconsistent tax system can discourage compliance, especially among small businesses.
   2. Tax morale suffers when there is uncertainty and a lack of transparency in cess collection and rate changes.
   3. This undermines the broader goal of formalising the economy.

Challenges and Way Forward

Challenge	Way Forward
Sluggish and uneven GST revenue growth	Rationalise GST rates and broaden the tax base by including items like fuels and alcohol in a phased manner.
Excessive reliance on cess, especially Compensation Cess	Phase out non-essential cesses and integrate them transparently into the GST structure.
Lack of trust and coordination between Centre and States	Promote cooperative federalism through fair revenue sharing and inclusive decision-making in the GST Council.
Weak demand, especially in urban areas	Implement demand-boosting measures and simplify GST to stimulate consumption and business activity.
Persistent structural inefficiencies in GST	Undertake time-bound reforms such as reducing the number of slabs, improving compliance systems, and strengthening IT infrastructure.

Conclusion

India’s latest GST collection highlights the need for overdue structural reforms. Systemic issues like narrow tax base, excessive cesses, and Centre-State friction hinder its potential. Simplifying the system, broadening coverage, and fostering cooperation are key to making GST truly efficient and growth-friendly.

 

Ensure IAS Mains Question Q. Even after 8 years, GST in India faces key structural and functional issues. Highlight the main challenges and suggest reform measures. (250 words)

 

Ensure IAS Prelims Question Q. Consider the following statements regarding the structural issues in India’s GST system The GST Compensation Cess is shared equally between the Centre and the States. Exclusion of key revenue-generating items like petroleum products and alcohol limits the effectiveness of GST as a comprehensive indirect tax. Which of the statements given above is/are correct? 1 only 2 only Both 1 and 2 Neither 1 nor 2 Answer: b. 2 only Explanation Statement 1 is incorrect: The GST Compensation Cess is collected by the Centre and is not part of the divisible pool; it is used solely to compensate States for GST revenue loss. Statement 2 is correct: Petroleum and alcohol are outside the GST framework, reducing its coverage and undermining the goal of “one nation, one tax”.