Who Really Pays for a Simplified GST?

The recent overhaul of the Goods and Services Tax (GST) has been presented as a long-awaited simplification, though its economic implications warrant closer scrutiny. Restructuring indirect taxes inevitably redistributes both gains and burdens, and GST 2.0 is no exception.

The government projects that lower rates will stimulate consumption and provide a buffer against external shocks such as the higher US tariffs on exports. Yet the optimism is difficult to reconcile with the underlying fiscal realities. The reform carries an estimated revenue shortfall of around Rs. 48,000 crore at a time when the combined deficit of the Centre and the states already exceeds 9% of the Gross Domestic Product (GDP).

To present this figure as a harmless implication or as a stimulus overlooks a crucial fact that states, which shoulder nearly 60% of public expenditure but lack meaningful fiscal autonomy under GST, will absorb much of the strain. Beneath the narrative of simplification lies a more sobering reality of fiscal stress, weakened federal balance, and a tax structure that remains regressive in design.

Consumption boost or fiscal gamble?

The reform seems as an attempt to use consumption as the driver of growth. With U.S. tariffs of 50% threatening nearly $48 billion worth of Indian exports, domestic demand is expected to take the strain. The government estimates that a lower GST will inject relief equivalent to 0.8–1.0% of GDP, enough to offset some of the external shock.

In Keynesian terms, it is a counter-cyclical demand stimulus where putting more disposable income in the hands of households will let multiplier effects ripple through the economy. Unlike direct fiscal transfers, GST cuts rely on firms to pass on benefits. The inflationary relief may be consequently muted, undermining the multiplier the government is banking on.

At the same time, the exchequer takes an upfront hit. Independent projections regarding the estimates of revenue losses are much higher, crossing Rs. 1.2 trillion once behavioural responses are accounted for. In an economy where the combined fiscal deficit of the Centre and states is already above 9% of GDP, such losses raise questions about how sustainable this stimulus may be.

From a macroeconomic perspective, GST 2.0 may lift demand in the short term, but may be fragile as a long-term strategy. Domestic consumption cannot substitute for export competitiveness indefinitely. India’s reliance on low-value sectors, poor productivity in manufacturing, and limited integration into global value chains are unfortunately not addressed only by cheaper electronics or cement.

Without structural export reform, tax cuts are at best a temporary cushion. The risks also extend to implementation, where MSMEs may struggle to adjust quickly. Having only weeks to reconfigure with the compliance systems, the smaller firms may face confusion with the already overburdening paperwork, diluting the transmission of benefits.

The distributional aspects need further attention. While essentials like medicines and some food items are exempt, the biggest gains are in middle-class consumption categories. A salaried family buying a Rs. 6 lakh petrol car will now save nearly Rs. 50,000 in tax. A real-estate developer sourcing cement will save lakhs on a mid-sized project. These savings matter, but they primarily benefit urban middle-class households and formal businesses. Poor households, which spend disproportionately on food and basic essentials, continue to face GST even at the 5% slab.

The state-centre faultline

GST 2.0 once again highlights the fragile state of fiscal federalism in India. With the introduction of GST in 2017, states surrendered their powers to levy sales, excise, and entry taxes in return for a promise of buoyant revenues and a time-bound compensation for any shortfall. That arrangement has now ended. Under the new structure, Jharkhand alone projects a revenue loss of about Rs. 60,000 crore by 2029, and other fiscally weaker states are anticipating similar gaps.

The Union government's argument about the 40% tax on sin and luxury goods to fill this gap appears as a weak foundation to build on. Consumption of high-end cars, aerated drinks, or tobacco is not only narrow but also highly sensitive to price hikes.

Raising rates further risks shrinking the tax base or fuelling illicit markets, which could reduce revenues rather than increase them. In effect, the GST system is being funded by leaning heavily on a small and unreliable set of goods, while states are left exposed to the fiscal consequences. This revenue fragility creates deeper imbalances in India’s federal design.

States are responsible for close to 60% of public spending, yet their own revenue-raising powers have been steadily hollowed out. The political economy reveals that states dependent on the Union government for transfers have less bargaining power in the GST Council, and opposition-ruled states in particular risk losing fiscal space. Far from strengthening cooperative federalism, GST 2.0 risks reinforcing a system in which the Centre consolidates financial control while states struggle to deliver on their responsibilities.

What is missing from the discussion is the broader macro-fiscal implications of this arrangement.  If GST revenue underperforms, the fiscal space for sustained public investment shall be further narrow. A consumption-led increase in revenue collection might be short-lived, if not complemented with productive gains and export diversification. This will, in turn, widen the fiscal deficit and push the government towards greater borrowing. At the same time, increased reliance on cesses that bypass revenue sharing with states will further aggravate fiscal and federal strains.

A missed opportunity

To its credit, GST 2.0 addresses long-standing anomalies like classification disputes over items like roti and paratha and brings India closer to global norms. However, simplification does not alone amount to a comprehensive reform. A more progressive reform would have expanded the list of zero-rated essentials, established a permanent state compensation mechanism, and paired indirect tax cuts with stronger direct taxation. Globally, several countries have proved that VAT/GST systems can be simple, equitable, and efficient in their design.

India’s revised framework towards simplification falls short of the deeper structural changes that would enhance both efficiency and fairness. It may stimulate demand and offer an electoral dividend, but unless followed by deeper reforms, it might be remembered as a short-sighted move.

Ubaid Mushtaq and Aurolipsa Das are Assistant Professors in the Department of Economics, SRM University - AP.

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