On Independence Day, the Prime Minister announced reforms to the goods and services tax regime that amount to a historic redesign. The GST regime, rolled out seven years ago, is considered a landmark reform. It is a destination-based consumption tax that aims to unify the country into a common economic market, with one system of indirect taxes. It eliminates interstate frictions. It is fully electronic and has in-built incentives to file taxes and claim credit on taxes paid in the value chain and, hence, is supposed to reduce leakages. It was also expected to be buoyant due to increased compliance.
But some shortfalls have become evident over seven years. The need for GST 2.0 was felt mainly because of the multiplicity of tax slabs, frequent changes in classifications leading to disputes, the lack of coverage of significant parts of GDP, and the huge compliance burden it has placed, especially on small businesses. It fails to fully reimburse exporters for all the domestic taxes paid, making exports uncompetitive. The new scheme will hopefully address all these shortcomings.
Another apprehension of the state governments is about shortfall in revenue. The GST reform was achieved as a grand bargain between the Union and state governments. The former gave up its right to impose excise and service taxes, and all states surrendered their right to impose state-level sales tax, value-added tax, and other sundry taxes such as octroi. The states were persuaded to surrender their tax autonomy by a legally binding promise to make up the revenue shortfalls. This is the GST compensation clause in the original Act of 2017, which expired in 2022. Now, the states are afraid that they will face a steep fall in their tax shares. GST 2.0 will, hopefully, also address this.
The fact is that most spending obligations are with the state and local governments, whereas two-thirds of the revenue is garnered by the Union, which is then devolved according to a formula. The time has come to re-examine whether the share of GST be split 60:40 in favour of the states, rather than the 50:50 in the current design. Different states have differing spending priorities depending on their developmental stages and reality. The proposed reform must ensure that states receive a larger, predictable share of GST receipts to meet their development needs
It is expected that in GST 2.0, the multiplicity of rates—from 5, 12, 18, 28 and 40 percent, with some other, additional rates—will be collapsed only into two rates: one for merit goods like food and medicine, and a standard rate for all other items. This simplification will reduce the disputes of classification and the resultant litigation. There will be a much smaller set of ‘sin goods’ for which a penal rate will apply.
Most items in the 12 percent and 28 percent slabs are expected to move to 5 percent and 18 percent, respectively, greatly reducing consumer confusion, litigation, and compliance costs. Some analysts’ research shows that nearly 75 percent of GST receipts will be routed through the 18 percent slab, and the effective average rate may drop by 1 percentage point, freeing purchasing power and stimulating growth.
However, this redesign may temporarily reduce GST revenues by roughly 0.5 percent of GDP (about ₹1.8 trillion per year). This loss has to be shared between the Union and state governments. It is to be treated as a fiscal boost at a time when American tariffs are pounding the Indian economy. Due to the lower effective GST rates and the possible decrease in prices by 7-10 percent, especially for high-value items, demand may go up. This coupled with improved tax compliance and winding down of the compensation cess—previously used for debt repayments of state governments—will help offset fiscal losses and can boost GDP growth in the next year. Some of the lost revenue will be recovered from compensation cess on tobacco, coal, and automotive sector, which will continue within the new GST framework.
A major weakness in the current GST system is the exclusion of some key sectors—petroleum, electricity, alcohol, and real estate. The planned reforms seek to expand GST net to these sectors, making tax receipts more stable and reducing distortions from fragmented supply chains. International best practices show that a broad tax base allows for lower rates overall, benefiting consumers and fostering compliance.
With its present multiple slabs and complex rules, GST 1.0 has led to an explosion in litigation and compliance challenges, clogging courts and raising business costs. Routine classification disputes and procedural errors often end up in judicial proceedings, creating enormous back-logs and financial strain. To resolve disputes efficiently, the government announced the GST Appellate Tribunal (GSTAT) in 2024, and its procedures were formalised in April 2025. The tri-bunal is set to manage appeals, provide rapid digital case management, and ease court over-load. Yet, as of August 2025, many states have not nominated essential members and full-scale functionality is still awaited. As part of the new reform, it is recommended that GSTAT be housed independently, outside the finance ministry, to ensure unbiased adjudication, akin to the Income Tax Appellate Tribunal model.
Finally, it must be recognised that an indirect tax like GST hurts the poor more than the rich, since the tax paid does not depend on the income of the payer. This makes it unfair and regressive. Hence, the lower slab is on goods mostly consumed by the poor. This way of making GST fair is a crude proxy to a direct income tax system. But ultimately, the overall balance of collections must tilt more towards direct taxes like income, wealth and corporate taxes, which can be designed to be equitable, fair and efficient. The GST burden, which is relatively disproportionate on the poor and small businesses, must be minimised.
The GST overhaul—a vision supported by economists, policymakers, and analysts—is a rare opportunity to create a cleaner, more growth-friendly, and just tax regime. With a streamlined rate structure, wider net, stronger fiscal federalism, operational tribunals, and a move toward progressive direct taxation, GST 2.0 can usher in strong, sustainable economic progress and a more equitable future.
Ajit Ranade | Senior Fellow, Pune International Centre
(Views are personal)