As the new rationalised Goods and Services Tax (GST) rates kick in, Prime Minister Narendra Modi promises a festive-season driven consumption boost for the middle classes, youth and MSMEs. One must ask the broader question on effectiveness of the current rationalisation and whether this resetting of rates rests on a fundamental misreading of the nature of issues afflicting India’s middle class.

The rationalisation assumes, at first, a very simplistic model of consumer behaviour, treating the Indian household not as a financially cautious decision-maker under strain, but as an automatic spender whose consumption will rise merely because disposable income has ticked up from a minor adjustment of rates.

It is true that a certain relief from the re-positioning of goods under lower tax slabs will help in increasing the consumer disposable income-by how much though is the real question? Given the MRPs or the base price of goods charged by producers/retailers are assumed to remain the same once tax rate changes kick in.

GST rejig’s projected savings are mathematically trivial

Any view of an automatic increase in consumer spending power ignores the current financial pressures on households too, which have been clearly reflected in recent RBI data on declining savings and rising debt.

The GST rejig’s projected savings are mathematically trivial when set against these structural burdens. Drawing from the NHFS data averages, if we Consider a four-member family with a monthly income of ₹90,000; the GST rationalisation translates to a saving of barely ₹2,800, or 3.1% of their income.

For a family, let’s say earning ₹60,000 per month, the savings are even smaller at just ₹1,300 per month, a mere 2.2% of their monthly earnings.

Recent RBI data show net household financial savings have collapsed to a near five-decade low at 5.1% of GDP in FY23, barely improving to 5.3% in FY24, while household liabilities climbed to a record 41% of GDP by mid-FY25. Non-housing debt alone accounts for 32.3% of GDP, pointing to households borrowing for subsistence rather than asset creation. In such conditions, the marginal propensity to consume (MPC) out of GST savings approaches zero, as families rationally prioritise deleveraging over discretionary consumption.

This additional income is far more likely to be used to pay down debt or shore up savings rather than spent on discretionary purchases. An hoped-for Keynesian multiplier never has a chance to take effect when increased disposable income is utilised for debt/interest on debt payments for households who have seen a 23% in the rise in their average per capita debt in the last two years alone.

These pressures are further compounded by rising borrowing costs.

RBI’s rate hikes since 2022 have increased home loan EMIs by nearly 19%, effectively nullifying any consumption gains from the GST cuts. At the same time, household real wages in urban areas have barely recovered to pre-pandemic levels, suggesting that families remain in a defensive financial posture and are unlikely to respond with a surge in discretionary spending.

PLFS data show that real monthly wages for male salaried workers in 2023-24 were 6.4% below 2017-18 levels, with self-employed men seeing a 9.1% decline. Even in Q1 FY25, overall wage growth averaged just 0.7%, propped up only by casual workers. This compositional shift towards precarious self-employment (58.4% of jobs in 2023–24, up from 52.2% in 2017-18) further weakens the policy’s consumption logic.

This critique, however, is largely centered on the urban experience. The policy’s logic unravels even more starkly when viewed through a rural lens.

The consumption basket of rural households, as per the Household Consumption Expenditure Survey, is heavily skewed towards unprocessed food items and local services, categories largely outside the ambit of these GST changes.

Granular HCES 2022-23 data show the GST burden is unequally shared: in rural areas, the bottom 50% and middle 30% together bear 62% of GST incidence, while in urban areas, the top 20% bear 41%. The rationalisation’s relief, concentrated on consumer durables and services, thus disproportionately accrues to wealthier urban households, reinforcing the urban-rural divide in consumption gains.

The tax cuts on packaged consumer durables, high-end personal care products, and services like gyms or salons are of little relevance to a rural family whose main financial worries are rising agricultural input costs and income uncertainty tied to the monsoon.

For them, any small gain is more likely to be used to repay high-interest informal loans or saved for the next sowing season rather than to buy a refrigerator. Rural wage growth has been barely 1-2% in real terms over the past year, and the persistently high demand for MGNREGA work underscores ongoing economic distress in villages.

A policy that betrays a strong urban bias

The much-discussed growth in “quick commerce” is an urban phenomenon; rural India remains untouched by these venture-capital-subsidised conveniences. The policy, therefore, betrays a strong urban bias, offering modest relief to a debt-laden middle class while doing almost nothing for the rural economy.

This miscalculation extends beyond consumers to the productive capacity of the economy itself. Businesses have a long history of absorbing tax cuts to boost margins rather than passing them on to consumers, a trend so common that it required repeated interventions by the National Anti-Profiteering Authority.

This was evident after the 2017 rollout of GST, when multiple consumer goods companies retained the gains from tax reductions, necessitating enforcement action. More importantly, the policy does not address the supply-side frictions that have kept private investment stagnant for nearly a decade.

True productivity gains come from capital investment and innovation, both of which require confidence and sustained private expenditure. This reform does not make a firm more likely to invest in new machinery or R&D.

The private investment cycle remains weak because of low-capacity utilisation and uncertainty about future demand, not because of the GST rate on air conditioners. It fails to address the structural problems facing MSMEs, the country’s main job creators, such as delayed payments and limited access to affordable credit, issues far more urgent than the tax rate on their products.

Delayed payments owed to MSMEs are estimated at ₹10.7 lakh crore (approximately 6% of GVA). This liquidity lock-up forces firms into expensive short-term borrowing, crowding out productive investment. By focusing on demand-side tweaks, the GST rejig ignores this systemic credit bottleneck that has far larger implications for capacity expansion and job creation.

Perhaps the most corrosive and least-discussed consequence of this policy is the pressure it places on India’s federal framework. The timing of the reform, conveniently aligned with the festive season and key state elections in Bihar, suggests its primary function is political signalling rather than serious economic strategy.

The resulting revenue shortfall creates a fiscal trap for state governments. Having already ceded much of their taxation power to the GST Council, and with the crucial compensation mechanism now expired, states are left fiscally vulnerable.

The rate cuts imply an annual revenue shortfall of about ₹60,000 crore (0.16% of FY26 GDP). With the divisible tax pool already shrinking from 88.6% in 2011-12 to 78.9% in 2021-22 due to rising cesses/surcharges, states’ fiscal autonomy is eroding. Given that two-thirds of public investment is state-driven, this represents a structural crowding out of long-term, high-multiplier growth.

State-level capital expenditure accounts for nearly two-thirds of India’s public investment, meaning that revenue shortfalls directly affect rural roads, irrigation projects, and healthcare infrastructure.

This squeeze reduces their ability to invest in essential public goods, undermining the very drivers of inclusive growth. The weakening of fiscal federalism is not a side effect but a predictable consequence of a centralising approach that prioritises the Union government’s fiscal position over that of the states.

Risks deepening fiscal vulnerabilities

Ultimately, the GST 2.0 reform is less an act of bold economic stimulus and more a reflection of policy timidity. It exemplifies a governance model that prefers populist, low-impact fiscal tinkering over the politically demanding structural reforms in land, labour, and capital markets that are necessary for long-term growth.

It is a policy designed to generate headlines and momentary relief, all while sidestepping the difficult work of genuine economic transformation. Rather than strengthening the economy, it risks deepening fiscal vulnerabilities and leaving the structural weaknesses of India’s growth story entirely unaddressed.

If policymakers aim for durable, inclusive growth, the focus must shift to restoring private investment confidence, easing MSME financing constraints, and rebuilding state fiscal capacities, measures that would convert short-term relief into sustained productivity, employment, and welfare gains for all. The GST rejig may provide some marginal gain in consumer spending budgetary base but whether they actualise into productive spending/investment preferences is a long shot.

Deepanshu Mohan is a professor of economics, dean, IDEAS, and director, Centre for New Economics Studies. He is a visiting professor at the London School of Economics and an academic visiting fellow with AMES, University of Oxford.

Ankur Singh is a Research Analyst with Centre for New Economics Studies (CNES), O.P. Jindal Global University.

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