India’s plan to streamline its Goods and Services Tax (GST) into a simpler two-rate structure is being hailed in New Delhi as a boost to consumption and a curb on inflation. But economists warn the move could turn into a fiscal gamble, with states expected to absorb a disproportionate share of the potential revenue loss.
The proposed “GST 2.0” would collapse the current four main slabs into two: a 5 per cent rate for essentials and an 18 per cent standard rate for most goods and services. The controversial 28 per cent “luxury” bracket would largely disappear, with nine-tenths of its items moving into the 18 per cent category.
The reform’s fiscal implications remain hotly contested. SBI Research has projected a relatively modest annual revenue loss of about ₹85,000 crore ($10.2 billion), which it argues could be offset by stronger consumption and existing cess reserves. It estimates that a demand boost could recoup nearly ₹52,000 crore ($6.2 billion) in additional GST revenue.
In stark contrast, IDFC First Bank has warned of a much steeper hit: as much as ₹1.8 trillion ($21.6 billion) in foregone revenue, equivalent to half a percentage point of GDP. That figure, if borne out, would nearly wipe out the Centre’s fiscal room for welfare schemes and infrastructure investment.
States Shoulder the Heavier Burden
The uneven distribution of losses adds to the tension. IDFC First Bank estimates that states could lose revenue equivalent to 0.36 per cent of GDP, more than double the Centre’s estimated loss of 0.15 per cent. Since states depend heavily on GST for nearly half of their own tax revenues, the proposed overhaul could squeeze development spending on health, education and infrastructure.
The problem is compounded by the looming expiry of the GST compensation cess. While the cess fund currently holds about ₹45,000 crore ($5.4 billion), it will lapse after March 2026, leaving states without a safety net against shocks. Poorer states with limited revenue bases are expected to be the hardest hit.
Warnings from Policy Experts
A new working paper by the National Institute of Public Finance and Policy (NIPFP) has flagged deeper risks. Authored by Professor Sacchidananda Mukherjee, the study warns that the proposed reform could exacerbate fiscal stress and widen inequality among states, given the wide variation in consumption patterns.
“In the absence of granular, rate-wise tax collection data and with wide inter-state variation in consumption patterns, any attempt to restructure GST rates is bound to be fiscally blind,” Mukherjee said.
The report also highlighted that the Finance Ministry itself admitted in 2024 that India lacks rate-wise collection data due to limitations in GST return filings, raising concerns that policymakers are “flying blind” into a revenue-sensitive reform.
Fiscal Federalism at Risk
The original GST architecture, introduced in 2017, was designed as a political compromise to ensure revenue neutrality for states. That consensus is now at risk. Since the expiry of constitutionally guaranteed compensation in 2022, states have resisted rate rationalisation, fearing large fiscal shocks without federal backstops.
Mukherjee’s analysis, using the latest Household Consumption Expenditure Survey, suggests that a flatter rate system would redistribute tax burdens in ways that favour richer, urbanised states at the expense of poorer, rural ones. Chhattisgarh, for instance, records most of its consumption in low-tax categories, while Goa has a larger share in mid- to high-tax goods. Flattening the rates would therefore shift revenue away from poorer states.
“The push for simplification may unwittingly accelerate fiscal inequality among states,” the NIPFP report cautioned.
Policy Uncertainty
As a possible fix, Mukherjee has suggested replacing the outgoing compensation cess with an “additional GST” after 2026, with states allowed a higher share of the proceeds. But critics argue such a move risks undermining the very logic of simplification.
The GST Council, where state finance ministers hold equal weight with the Centre, will face the task of balancing the Centre’s political push for reform against states’ demand for fiscal protection. Without credible compensatory mechanisms, analysts warn that states may resist the overhaul outright.
A Reform Gamble?
The larger question is whether India can afford to risk state finances in the name of administrative simplicity. With GST collections already volatile—rising above ₹1.6 trillion ($19 billion) in some months and slipping below in others—states worry the promised consumption-led rebound may not materialise quickly enough.
What New Delhi calls simplification, critics fear, may instead become centralisation—tilting fiscal power further towards the Centre while states absorb the fallout. (5WH)
