GST 2.0: Cracks in the System Still Run Deep

The government is moving swiftly to implement GST rate rationalisation, widely referred to as GST 2.0 or the big-bang reform. The Prime Minister had highlighted this vision in his Independence Day address from the Red Fort on August 15, and the GST Council subsequently approved the new structure at its meeting on September 3. The new rates took effect on September 22.

The 56th meeting of the GST Council on September 3, 2025, stands out as a historic milestone in India’s tax landscape. Instead of making incremental adjustments, the Council introduced far-reaching reforms designed to align the tax framework with the aspirations of Viksit Bharat 2047. The simplification of the GST structure represents a clear move toward greater transparency, equity, and ease of compliance. By responding to the long-pending demands of both businesses and consumers, the reform highlights that taxation is no longer viewed solely as a tool for revenue collection but as an instrument to drive growth, ensure stability, and enhance India’s global competitiveness.

At the heart of this reform lies the consolidation of multiple GST slabs into a streamlined system. The Council introduced two broad categories—18 percent as the standard rate and 5 percent as the merit rate—alongside a sharply higher 40 percent slab reserved for luxury and sin goods. This restructuring has not only reduced the complexity of the tax system but also lessened the compliance burden for businesses while making the regime more citizen-friendly.

Notably, the rationalization of around 440 goods has resulted in significant rate cuts: a majority have shifted from 12 to 5 percent, several from 12 to zero, and others from higher brackets to more moderate ones. This recalibration is expected to lower the average GST on goods to a range of 8–10 percent, providing immediate relief to consumers.

The broader implication of this reform is its progressive impact on the economy and society. For years, ordinary citizens have shouldered the burden of indirect taxes that inflated household expenses. The Council’s decision dismantles this rigid structure and redistributes the load more equitably, thereby improving purchasing power and stimulating demand.

While most services—comprising about 60 percent of GDP—will continue under the 18 percent bracket, the sharp reduction in levies on goods creates space for greater affordability and wider consumption. This bold restructuring, therefore, is not only a milestone in India’s tax history but also a step towards fostering inclusive growth and strengthening the foundations of a modern, globally aligned tax regime.

What drove the need for these changes?

Several factors make the timing of the GST rate cuts appropriate. The period for levying the GST compensation cess is nearing its end. Legally, it can be imposed until March 31, 2026, or until the Centre clears its outstanding loans, whichever is earlier.

According to the finance minister, these loans may be repaid within the current calendar year. Had the cess been withdrawn without adjusting the base rates on tobacco and similar products, these goods would have become much cheaper, an outcome the government could not afford to signal. This created a deadline for the new GST structure.

Another factor is the likely fallout of the U.S. imposing a 50 per cent tariff on Indian imports. Despite India’s robust 7.8 per cent GDP growth in this financial year’s first quarter, the government has retained its full-year forecast at 6.3–6.8 per cent, signalling an expectation of slowing growth. The GST rate cuts are expected to cushion this external shock by boosting domestic demand and easing pressures on businesses and households.

That said, the government has officially denied any direct link between the tariff impact and the GST reforms. It maintains that the changes are part of a broader structural push to simplify and modernise the tax system, rather than a reactive measure to global trade developments.

Unresolved Challenges Ahead

After the recent announcement of GST reforms, optimism is running high about a potential boost to consumption demand. However, this expectation contrasts with the government’s own near-term estimate of a modest ₹48,000 crore revenue loss in FY26 — just 2.3 percent of the projected ₹20.6 lakh crore gross GST collections (excluding cess) for FY25. The relatively small impact is partly offset by higher levies on sin goods, stronger consumption, and a likely reduction in refunds on input taxes under the new regime.

Yet, this design also creates fresh concerns. Industries that fall into the 5 percent or nil tax categories — now expanded to cover nearly 575 items compared to 300 earlier — may face higher tax costs due to limited or no input tax credit (ITC). With most inputs, services, and capital equipment taxed at 18 percent, businesses such as FMCG, pharmaceuticals, textiles, bicycles, kitchenware, and retail insurance could carry an unavoidable “silent tax.” Estimates suggest that extending full ITC to all goods in the 5 percent slab would have led to a revenue loss of ₹1.5–2 lakh crore annually.

The insurance sector illustrates this dilemma clearly. With health and life insurance for individuals exempted from GST, insurers lose the ability to claim credits on agent commissions, rentals, and other services. Their costs may rise, pushing them to hike premiums by up to 5 percent. This would dilute the intended benefit of GST reduction for policyholders and potentially undermine efforts to expand coverage. A more rational approach would be to tax only the profit or underwriting margin of insurers while allowing full ITC on expenses, or at least applying “zero-rating” to retail policies.

Despite progress, several unfinished issues remain that require attention in the next reform phase.

India still has a complex GST rate structure. While the 12 percent and 28 percent slabs have been merged, rates range from as low as 0.25 percent to as high as 40 percent. Mature economies typically follow simpler frameworks — either a single rate or one standard rate with one or two reduced rates. Over time, India too must converge toward a genuine two-rate structure, and eventually a single rate, to minimize classification disputes and compliance costs.

The GST framework was meant to eliminate cascading taxes. Still, Section 17(5) of the CGST Act continues to block ITC on construction inputs like cement and steel, as well as employee-related costs such as insurance. While this boosts revenue in the short run, it inflates business costs and undermines competitiveness. Allowing ITC on such items would lower project costs and make the tax system more consistent with its original intent.

Key sectors, including petroleum products, electricity, alcohol, and real estate, remain outside the GST net. These exclusions, driven by states’ fiscal concerns and regulatory complexities, break the credit chain and raise costs. For example, airlines cannot claim ITC on aviation turbine fuel, and manufacturers pay higher prices for petroleum-linked inputs and electricity. Over time, bringing these sectors under GST would enhance competitiveness and efficiency.

Refunds under inverted duty structures are restricted to input goods, excluding input services. This particularly burdens industries such as pharmaceuticals, textiles, and packaging, where services like consultancy and legal fees are taxed at 18 percent. The resulting credit accumulation raises working capital pressures and runs counter to the idea of a seamless credit chain.

Although GST was designed as a technology-driven simplification, businesses still grapple with multiple registrations, state-level audits, and frequent return filings. A shift toward a “one nation, one registration, one return” model would align India with global best practices and ease the compliance load. Disputes persist around issues such as corporate guarantees and allocation of common service credits.

For example, intra-group guarantees — typically provided without monetary consideration — are treated as taxable supplies, which can spark valuation disputes. Similarly, confusion persists between the input service distributor mechanism and cross-charging, with inconsistent industry practices inviting scrutiny.

In its eighth year, GST is more stable and effective than at inception, yet the reform journey is far from complete. Addressing these structural gaps — rate rationalisation, ITC liberalisation, inclusion of key sectors, refund reforms, compliance simplification, and more explicit rules — will be critical for evolving GST into a truly seamless, business-friendly, and growth-oriented tax system.

The recent tax cuts on essential goods and services, touted as a “festival of savings,” are nothing more than a superficial gesture. It was the same government that imposed the GST with multiple slabs, a move that has strained the finances of ordinary citizens. We cannot ignore the harsh reality that millions of our compatriots continue to live in poverty and low-income conditions. Token measures are insufficient; what is urgently required are deep structural reforms that genuinely enhance the purchasing power of the majority. We must reshape our social and economic order to be truly just— “just” not as a slogan, but as a binding principle guiding every policy.