Mint Explainer | GST cuts are huge. How can the government afford them?
In the biggest GST reform to date, the government shifted most products in the 12% slab and some in the 18% slab to 5%, and discontinued the compensation cess. How did it do all of this without destroying its tax revenue?
Last month the GST Council implemented the biggest reform to date in the eight-year-old indirect tax system, seeking to simplify it and simulate consumption. More measures to make GST more user-friendly are in the offing, and policymakers expect the tax cuts and simpler structure to boost India’s economic growth and investments.
The reforms not only lowered the tax burden, but also eliminated the 12% and 28% slabs. Most products in the 12% slab and some in the 18% slab were moved to 5%. Small cars were shifted from 28% to 18%, and even sports utility vehicles saw an effective cut of 45-50% to 40%. In addition, the GST compensation cess, which brought in ₹1.49 trillion in FY25, was discontinued.
So how was the government able to enact such significant cuts without cratering its tax revenue?
Mint takes a look at the fiscal calculations that underpinned the reform.
What is the official estimate of the fiscal impact of the GST reforms on the exchequer and the magnitude of the stimulus?
When the tax reform was announced last month, revenue secretary Arvind Shrivastava said the “net revenue implication" of the tax slab restructuring was about ₹48,000 crore based on FY24 consumption data. As for the consumption stimulus from the tax reform, union finance minister and GST Council chairperson Nirmala Sitharaman said later that the tax relief would infuse ₹2 trillion into the economy.
The official position is that the money not collected by the government as GST will find its way back into the economy through spending, and that higher consumption, tax buoyancy and easier compliance will boost tax revenue receipts. Shrivastava had said the restructuring was “fiscally sustainable".
Corporate announcements and commitments from industry bodies of a full pass-through of the tax relief to consumers across products and services—including automobiles, other consumer durables, food products and health and life insurance policies—show companies are indeed lowering prices.
How is the government able to limit the revenue hit despite significant tax cuts?
The most important factor that enabled the tax reduction was the discontinuation of the GST compensation cess, effective 22 September (barring tobacco products, which will be phased out in the near future).
The cess was an additional levy on certain goods like automobiles and tobacco collected by the central government. Its sole purpose was to compensate state governments for any revenue loss they incurred during the initial five years of transitioning to the GST regime starting July 2017. That period ended in 2022, but the cess was retained to pay back the Centre had taken to give liquidity support to states during the pandemic, and was originally due to expire by March or earlier.
In FY25, the central government collected ₹1.49 trillion in cess. Scrapping the cess created immediate fiscal space for tax cuts, said a person aware of the discussions in the government, who did not wish to be named.
The tax cut, including on essential items, was thus made possible by the expiry of cess. Even the new special rate of 40% for SUVs is lower compared the earlier effective rate of 45-50% including the cess. Eliminating the cess, which was levied for specified time-bound purposes, enabled a simpler GST structure with lower rates.
And instead of only cutting the tax on the few items that previously had the cess (like cars), the government spread the cuts across a wider range of goods and services. This allowed it to announce significant rate cuts for essentials and items used by the middle and lower classes, thus maximising the public benefit and boosting consumption.
“The government was conscious of the need to have fewer GST slabs for a long time, but the expiry of the cess gave the right opportunity to implement it with significant benefits to consumers across the social strata," said the person quoted above.
Are there any early signs of a consumption boost?
Some early indicators show a strong uptick in consumption. The Federation of Automobile Dealers Association said earlier this week that overall retail sales jumped 34% year-on-year in September. The momentum was particularly visible in two-wheelers (36%), three wheelers (24.5%), passenger vehicles (34.8%) and commercial vehicles (14.8%). Other high frequency indicators such as GST revenue collected from September sales and e-way bill generation data for the month are yet to be released.
Maruti said on 1 October that the GST reforms had significantly improved customer sentiment, as reflected in its highest-ever deliveries of 165,000 units in the first eight days of the Navratri festival.
However, it could take time for this favourable consumer sentiment to be reflected in actual manufacturing data. The HSBC India Manufacturing Purchasing Managers’ Index (PMI) stood at 57.7 in September, comfortably above the 50 mark that separates expansion and contraction. The PMI reading remained well above the long-term average, although it lost some momentum from August.
What’s the ultimate goal of the reforms?
Even as external factors such as US tariffs and visa restrictions increase uncertainty in business planning, policymakers expect positive consumer sentiment and higher consumption demand from the reforms, coupled with greater liquidity and interest rate cuts by the RBI, to accelerate private investment. It is pinning hopes on such a revival of private investment to complement its own capital expenditure, boost economic growth and create jobs.
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