Few things affect the lives of Indians on daily basis as persistently as the implication of the Goods and Services Tax (GST). Indirect taxes are levied independently of knowing a person’s income or consumption power and their burden is equal, irrespective of whether they earn a rupee or a crore.
Launched in 2017 with the promise of simplifying the nation’s fractured indirect tax regime, the GST has often felt less like a single-lane highway and more like a maze of flyovers, detours and toll booths.
Now, the proposed GST 2.0 reform promises a two-rate system of 5 percent on essentials, 18 percent on standard goods, and a sharp 40 percent levy on demerit and luxury items (this slab is still existent and would impact prices of luxury or sin goods).
What Does 'Rationlisation' Mean?
This latest call for “rationalisation”, a euphemism for pruning the number of slabs and correcting anomalies, arrives with the weight of both hope and trepidation. For the middle classes, it is being sold as relief - an unburdening of the basket of goods that shape everyday life.
Milk powder, cooking oil, detergents, televisions, motorcycles: all promise to be lighter on the pocket. Consumption, the government argues, will swell, demand will awaken, and the tired pulse of the economy will quicken again.
The GST Council’s deliberations come at a time when the Indian middle-income classes have been squeezed due to high tax incidence, rising prices and living costs, and stagnating real incomes across sectors. Those, most aspirational are also the most anxious, feeling hemmed in by rising living costs across cities.
Rationalisation of an indirect tax system like the GST, if it indeed reduces the number of slabs and closes the gaps where goods of similar utility are taxed differently, could act as both balm and spur.
A toothpaste is taxed at 18 percent while essential Ayurvedic medicines are at 5 percent, or a restaurant meal taxed at up to 18 percent while packaged food escapes at 5 percent. Such discrepancies erode the very trust a unified system was meant to build.
The data, as noted by the Reserve Bank of India (RBI) and Finance Ministry briefings, suggest that consumption demand in India has been stubbornly uneven, with discretionary spending particularly fragile. Streamlining slabs, in theory, lowers compliance costs and lends predictability nudging families towards consumption instead of hesitation.
The Middle-Class Crossroads
For the middle-income Indian, this rationalisation could feel less like policy and more like small relief at the till: shampoo, noodles, modest appliances nudged downward, just enough to prompt retained hope.
The proposed structure, with two principal rates of 5 and 18 percent and a higher 40 percent levy reserved for five to seven demerit goods such as pan masala and tobacco, is projected by SBI Research to cause an average annual revenue loss of about Rs 85,000 crore. Yet this fiscal sacrifice is expected to be offset by a substantial demand-side effect, with consumption expenditure projected to rise by Rs 1.98 lakh crore.
Less attention is paid to the fact that India's GST has progressively moved from being a high-rate regime to one of lowest weighted averages across large emerging markets.
According to recent studies by SBI, at launch, the effective rate was 14.4 percent. By September 2019, it had already reduced to 11.6 percent, and would potentially decline further to 9.5 percent with proposed rationalisation.
What few understand is that such a rate puts India's average rate of indirect taxes below many middle-income countries, wherein the Value Added Tax (VAT) and GST rates are often between 12 to 20 percent. For the future fiscal year, immediate revenue loss is pegged at Rs 45,000 crore, assuming implementation between October and March.
With the reductions in income taxes announced through the Union Budget, the overall impact aggregates to Rs 5.31 lakh crore of additional consumption expenditure that translates to roughly 1.6 percent of GDP, as per a study by SBI. Far from being a marginal adjustment, it is a large shot of liquid funds into the system that is poised to raise aggregate demand when household consumption contributes to nearly 60 percent of GDP.
The inflationary consequences are projected to be modest. Headline CPI could moderate by 20 to 25 basis points as taxes on mass consumption items decline. Within specific categories, the reduction in GST rates on essentials such as food and clothing from12 percent to 5 percent is expected to translate into a 10 to 15 basis point decline in inflation, assuming a 60 percent pass-through in food and 25 percent in other goods and services.
A further 5 to 10 basis point easing is anticipated from the rationalisation of services.
A little-known feature here is the asymmetric pass-through: while the state can legislate reductions, actual consumer benefit depends heavily on competitive pricing and compliance with anti-profiteering provisions, which are still weakly enforced.
The compensation mechanism also hides a technical twist. While the GST Compensation Cess on tobacco, aerated drinks, and motor vehicles was originally designed as a temporary bridge to protect states from revenue loss, it has quietly become a structural pillar of the system. The new rationalisation, which deepens the reliance on a 40 percent levy for demerit goods, signals not just simplification but a shift towards a dual-purpose tax both consumption-driven and corrective in nature.
The Federal Fault Line
As deliberations on GST 2.0 intensify in New Delhi, the political economy of revenue loss is already bleeding into state capitals.
As per a recent report, in Hyderabad, Finance Minister Bhatti Vikramarka on Friday cautioned that Telangana faces the prospect of a revenue loss approaching Rs 7,000 crore annually, nearly 15 percent of its GST collections, a figure that directly threatens its ability to fund welfare spending which already absorbs over 80 percent of the state budget.
In Chandigarh, Punjab’s Finance Minister Harpal Singh Cheema flagged that the state could see a similar shortfall, warning that any further erosion of GST devolutions without a guaranteed compensation framework would imperil Punjab’s fragile fiscal base, already struggling under high debt.
In light of recent changes, states must contend, on priority with immediate gaps in revenue that could destabilise their welfare commitments and fiscal stability.
Uncharted Territory
Middle classes need greater opportunities for upward mobility which help increase their incomes and consumption demand power. Tinkering with GST rates will only marginally help them in balancing the squeeze being felt from rising costs and limiting opportunities.
Forecasting ahead, two scenarios can be visualized for GST buoyancy. In the optimistic scenario, GST buoyancy jumps to above 1.5 from prevailing rates of 1.1- 1.2 on account of enhanced compliance and formalisation. This would compensate for revenue losses in two to three years and also allow space for further direct tax rationalisation, entrenching India's move to a consumption-based growth model.
However, the revenue shortfall widens as compliance gains plateau.
States, already strained with shrinking compensation windows, could find their fiscal deficits deteriorating beyond tolerable thresholds, pushing them into sharper borrowing and crowding-out risks. In such a scenario, the Centre may be forced into a politically costly rollback revising slabs upward or reimposing cesses, thereby undermining the very credibility of GST 2.0.
A tax code is never merely numbers on a page; it is the story of who eats and who waits, of what the Centre promises and what the states must forfeit. Taxes, after all, are the story of a nation deciding, again and again, who must pay, and for what vision of the future. So far, the poor and weak in India pay more in taxes than what the rich can pay-yet don’t pay.
(Deepanshu Mohan is a Professor and Dean, OP Jindal Global University. He is a Visiting Professor and Fellow at LSE, and University of Oxford. Geetali Malhotra is a Research Assistant with Centre for New Economics Studies (CNES), OP Jindal Global University. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)