GST: Unmaking of a Big Bang reform

The GST is a classic case of how a Big Bang reform can go awry if not handled properly, and if the tax system and overall economic policies don’t generate enough resources even when economic growth is robust.

It had a grand beginning with a midnight session of the Parliament on June 30-July 1, 2017 – reminiscent of the one of August 14-15, 1947, heralding India’s Independence – promising to be a “Good and Simple Tax”, bring “one-nation-one-tax” system, and boost “cooperative federalism”. Nine years down the line, it has become quite something different.

Instead of eliminating the cascading impact of multiple indirect taxes the Centre and states imposed on goods and services until then – the very raison d'être of it – which would have reduced the tax burden on ordinary consumers, by default, it is doing the heavy-lifting to mobilise resources for the government capex.

Note, it was a fight led by big businesses and big businesses cheered it when it came. The Oxfam International’s 2023 report saying that only 3-4% of GST came from the top 10% and 64.3% of the GST collection comes from the bottom 50% (the rest from the middle 40%) can surely be questioned for exactitude – as the Centre did then– but this can’t be far off the mark. The GST, after all, is an indirect tax paid by all consumers – irrespective of their capacity to pay more tax.

The recent controversy over the hike in GST on popcorn – from 5% on plain popcorn to 12% for salted and 18% for caramelised ones – is a symptom of this.

Multiplicity of GST on same item is the norm 

Popcorn episode is not new.

Recall the viral video of September 2024 showing a Coimbatore restaurateur D Srinivasan of the Annapoorna restaurants apologising to Finance Minister Nirmala Sitharaman for flagging the oddity of 18% GST on bun with “cream”, against 0% GST on plain bun.

There are many legal battles around such multiplicity. One legal battle over 18% GST on Malabar ‘parota’, against 5% on bread, ended in April 2024 with the Kerala High Court ruling 5% GST for both because both are wheat products. A similar battle over frozen paratha (18%) against frozen roti (5%) had been upheld by a Gujarat appellate authority in October 2022.

Milk and milk products also attract multiple GST rates. While fresh and pasteurized milk attract 0% GST, milk and cream in concentrated form or containing sugar, milk powder/food for babies etc. attract 5% and condensed milk, butter, ghee and cheese 12%.

These are one aspect of what the GST shouldn’t be. The other is imposing 5% GST on food items consumed by the poor – unbranded but pre-packaged wheat, rice, curd, lassi, puffed rice, mutton and fish – imposed in July 2022. This was a first for India.

There is yet another.

It isn’t clear exactly when it began but on December 23, 2024 news hit that the Uttar Pradesh government-run Kalyan Singh Super Speciality Cancer Institute was charging 18% GST on job applications for all categories (general, SC, ST and OBC). It had done the same in its January 1, 2024 notification too. The New Year brought another surprise. A national daily reported that playground operators in Uttar Pradesh’s Noida and Greater Noida had failed to deposit 18% GST on rentals (from ₹8,000-20,000) for allowing cricket matches – resulting in significant revenue loss.

All these may have sneaked in after 2017, but the skewedness is very much intrinsic to it.

Right from its inception, rough diamonds, precious and semi-precious stones attract 0.25% GST, polished diamonds, gold, platinum and silver ornaments attract 3% GST – but humble tendu leaves, ‘katha’ (used in ‘paan’) and biscuits supplied to pre-school children at Anganwadi centres 18%. All these reflect successful industrial lobbying so evident in trade – for example, the Ministry of Steel is now seeking a hike in Customs duty on steel from 7.5% to 15% to protect the industry from cheap Chinese import.

Quite apparently, all of the above are results of multiple policy and governance failures.

What made GST complex?

First is lack of logic and evidence in design and operational elements at the inception of GST.

More than one and half years before it was introduced in 2017, then CEA Arvind Subramanian (2014-2018) had released “Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)” in December 2015. It analysed global practices and recommended three GST rates – 12% (Centre plus states) covering most items with two standard rates varying between 17-18%. The UPA under Manmohan Singh, which worked on the GST for years, had tentatively fixed a single rate of 18%.

But when the GST was rolled out, it subsumed only eight central and nine state indirect taxes, not all, and had other undesirable elements: 

1. Excluded high-yield indirect taxes like Excise and Customs on high-value goods: Petroleum and its products, alcohol for human consumption and electricity (continues till date) – contrary to “one-nation-one-(indirect) tax” promise. Crude oil and petroleum products, for example, attract multiple indirect taxes along with GST (IGST, CGST, SGST and UTGST), like Royalty, Cess, Sales Tax/VAT, Octroi, Entry Tax (PPAC). 

2. Listed 8 rates – 0%, 0.25%, 1% (“composite scheme”), 3%, 5%, 12%, 18%, 28%. Plus, Compensation Cess.

3. Put high compliance burden with 988 GST returns to be filed every single year (two monthly returns, GSTR-1 to GSTR-9, plus multiple forms within those classifications) – to both central and state governments. 

A World Bank study (January 2018) had said, India’s GST was more complex than the comparable systems in 115 countries, adding to the cost of compliance and incentivising tax evasion; 49 countries had a single rate, 28 two rates and only four other countries had four or more rates (Italy, Luxembourg, Pakistan and Ghana) and India’s 28% was “the second highest” in the world.

It is clear there was little genuine debates and consultations – internal or external.

For example, Subramanian may have reacted strongly on December 21, 2024, when the popcorn episode broke. He took to ‘X’ lamenting that it was “a national tragedy, violating the spirit of the Good & Simple Tax” and that “the folly is compounded…we are veering to greater complexity, difficulty of enforcement & just irrationality. Sad.”

But he was silent when the GST was designed and rolled out under his watch. He kept quiet on two other significant policy decisions too – the demonetization of 2016 and introduction of the 2011-12 GDP series in January 2015. He began critising all three after demitting office in September 2018. He called the demonetisation and GST “twin shock” that derailed the economy in November 2018 and panned the new GDP series in June 2019 for “overestimation” of growth by 2.5-3.7 percentage points a year during FY12-FY17.

There is no disputing that the GST hurt smaller business (SMEs) and their business shifted from informal to formal because of the Input Tax Credit (ITC) provision. Much before Subramanian, former Prime Minister Manmohan Singh had called it one of the “twin blow” to the economy in November 2017 and before that, then Congress vice president (now LoP) Rahul Gandhi named it “Gabbar Singh Tax” in October 2017.

That questioning the Centre on GST is not appreciated became obvious when the Annapoorna restaurant owner was made to apologise in September 2024 (mentioned earlier).

Second, and equally important one, is multiple other policy debacles – which turned the GST into a tool to generate revenue.

Sluggish private capex despite subsidies and stagnant revenue

The Centre is caught in a vicious circle – of its own making.

In September 2022, Finance Minister Nirmala Sitharaman revealed (in the famous ‘Hanuman’ speech) that her government (i) cut corporate tax in September 2019 and (ii) gave PLI subsidies (starting with March 2020) as demanded by the industry (“Alright, bring the rate down; the tax rate was brought down…. Give production linked incentive (PLI) – we have given PLI. I want to hear from the India Inc. what is stopping you?”).

It has also been (iii) generous in tax incentives to big corporations, called “revenue foregone” or “revenue impact of tax incentives”. More profit-making ones get more incentives that results in least effective tax rate. For example, effective tax rate for maximum profit-making ones (PBT of over ₹500 crore) is 20.4%. In FY23 (up to which FY25 receipt budget gives data), revenue foregone jumped to ₹1.09 lakh crore – from ₹96,892 crore in FY22 and ₹75,218 crore in FY21.

It has also been (iv) generous in writing off corporate loan defaults (NPAs) – ₹1.7 lakh crore in FY24 and a total of ₹16.3 lakh crore in 10 fiscals of FY15-FY24.

But private corporate capex remains where it is (below par).

Private corporate GFCF remains below 11% of the GDP for six consecutive fiscals from FY18 to FY23 (up to which data is available). This is far below the peaks of 11.9% in FY16 and 16.8% in FY08. Now the CMIE says, new projects fell by 22.1% (Y-on-Y) in Q3 of FY25.

Meanwhile, something else happened.

The corporate tax cut led to massive revenue loss of ₹2.28 lakh crore in FY20 and FY21 and corporate tax collection have fallen below that of income tax in FY21, FY23, FY24 and FY25 (BE). It is stuck at 3-3.1% of the GDP in the post-pandemic fiscals of FY22-FY25 (BE) – lower than 3.3% in FY16 (receipt budget of FY25).

No wonder, the Centre’s gross tax remains stagnant – rangebound at 10-12% of the GDP during 10 fiscals of FY16-FY25 (BE).

Its non-tax revenue from disinvestment (including privatisation or strategic disinvestment) has also been hit.

Starting with the interim budget of FY25 (February 1, 2024), this receipt is no more disclosed – but clubbed with “others” under “miscellaneous capital receipts”. The “miscellaneous capital receipts” (non-debt) fell from the budgeted ₹61,000 crore in FY24 (BE) to ₹30,000 crore in FY24 (RE) – below ₹46,035 crore (actual) in FY23 from budgeted ₹65,000 crore in FY23 (BE) (receipt budgets FY25 and FY24).

How does the Centre get tax revenue to push government capex to “crowd-in” private capex – as it is doing since 2022?

Herein comes the GST’s role to generate revenue.

The FY25 budget shows, the GST has become the main driver of tax – accounting for the most of the Centre’s gross tax in FY20, FY21 and FY23 and second most in FY18, FY19, FY22, FY24 and FY25 (BE).

The following graph show composition of the Centre’s gross tax after GST came in FY18. 

Sure, the Centre collects large revenues from other indirect taxes.

Excise, Customs, Taxes on UTs and “Other taxes and duties” averaged 19% of the Centre’s gross tax during FY18-FY25 (BE). In FY25 (BE), those four account for ₹5.7 lakh crore or 15% of gross tax.

States also collect such taxes (on petroleum and petroleum products, alcohol for human consumption etc.) and don’t want to give up for obvious reasons (having given up nine indirect taxes of their own).

Consequently, unlike developed world, India’s tax system is becoming even more regressive (graph below). The gap between direct and indirect taxes (Centre+states) which had fallen from (-)6.5% of the GDP in FY01 to (-)2.1% in FY10, has risen sharply to (-)4.1% in FY24 (RBI data).

‘Cooperative federalism’ gone haywire

As for “cooperative federalism”, states gave up most of their indirect tax rights in 2017 and in return, they were to be compensated for five years from FY18 – at 14% annual hike. But the Centre stopped paying the GST compensation in FY21 and FY22 – citing fiscal constraints after giving a massive corporate tax cut of ₹1.45 lakh crore in September 2019 (FY20).

Instead, the Centre gave repayable loans of ₹1.1 lakh crore in FY21 and ₹1.58 lakh crore in FY22 – in gross violation of the GST (Compensation to States) Act of 2017. Later, the Centre decided to continue with collecting the GST Compensation Cess beyond FY22, until FY26, to recover these loans.

Fiscally, there are other ways “cooperative federalism” is not working.

For one, tax devolution governed by the 15th Finance Commission (FC) award averaging 31.7% during FY21-FY25 (BE) – against 41% mandated. This gap – averaging (-)9.3 percentage points – is consistently going up – from (-)4.1% during the 13th FC period (FY11-FY15) and (-)7.1% during the 14th FC period (FY16-FY20).

The Centre’s “total transfers” averages 36.2% during the same period (FY21-FY25 (BE) – as against about 50% before 2014 (14th FC report). The RBI’s “state finance” report of December 2024 further confirmed this trend pointing out “contraction in non-tax revenue and grants from the Centre”.

It is easy to hyphenate states and the Centre for the GST’s skewed structure and drive to generate more tax. Rathin Roy, former member of EAC-PM, for example was “angry” over the popcorn development, calling it “grotesque Mohammed Shah Rangila like dereliction of duty” with both the Finance Minister and 30-odd state finance ministers.

But what is often overlooked is that having given up most of their indirect tax rights, states are willing to any move that brings higher GST as that raises the prospects of more revenue.

To that extent, the GST is a collective failure and calls for an overhauling – simpler and fewer rates. 

The author writes on economics, governance and politics. His books include 'What Derailed the Indian Economy' and 'Attack on the Idea of India'. Views are personal.