The Goods and Services Tax (GST) is often described as independent India’s most pathbreaking indirect tax reform. Here, India had the latecomer’s advantage of learning from the experience of others — preceded as it was by about 160 countries in the implementation of a GST/value added tax (VAT). However, an India-specific GST paradigm had to be evolved considering our specificities. The destination-based consumption tax subsumed several pre-existing central and state taxes, with the aim to improve the tax effort (tax-GDP ratio), end tax cascading, enhance efficiency and competitiveness, reduce prices, and accelerate Gross Domestic Product (GDP) growth. The states had to surrender more taxing powers than the Centre, raising concerns about their fiscal autonomy. Hence, they were guaranteed compensation via a cess that assured 14% growth in their GST revenue for the initial five years. As the regime is about to complete seven years, it is pertinent to explore where the system stands with regards to the promises made and the way forward.

There were concerns regarding poor revenue performance in the initial years of implementation. However, the performance has been impressive following the economic recovery from the Covid-19 pandemic; revenue collections touched new highs month on month in FY24. The average monthly collections in FY24 stood at ₹1.68 lakh crore with a growth rate of 11.6%. The gross GST revenue in April 2024 (start of FY25) reached ₹2.1 lakh crore, setting a new collection record.

However, a comparative analysis of revenue performance between the pre-and post-GST periods reveals that an increase in the tax base is still awaited. The average of total taxes subsumed under GST during 2012-17 was 6.13% of GDP. During 2017-2023, the GST-GDP ratio, excluding GST compensation cess, declined to 5.65%, whereas the ratio barely maintained the previous level of 6.13% if GST compensation cess (0.48% of GDP) was included.

The states, in general, performed poorly in the post-GST period compared to pre-GST. In 16 out of the 17 major states, the share of GST in Gross State Domestic Product (GSDP) declined in the post-GST period, with Jharkhand being the only exception. Further, 15 out of 17 major states showed a decline in GST’s contribution to their own tax revenue (OTR) collection. The only exceptions here are Maharashtra and Tamil Nadu. Given this slip between the cup and the lip, it is pertinent to reflect on the underlying factors and the future agenda for reform.

The GST performance recorded so far must be assessed against a host of factors, including the plethora of rates that presumably stood in the way of increased compliance in tax collection on account of, among other factors, the proliferation of fraudulent claims for input tax credit. The poor performance of the states needs to be viewed in the context of an equal division of total tax revenue between the Union and the states. Another issue pertains to the operation of the Integrated GST (IGST), wherein it was expected that, being a consumption-based tax, consumer states would gain. However, evidence from a consumer state like Kerala reveals that the IGST-SGST ratio is only at a low level of 1.2, indicating a significant loss of revenue for the state.

GST in India is still evolving and needs reform to ensure that its social marginal product is positive. From the perspective of the states, there is much to be gained from redesigning the division of GST revenue between the Union and the states, wherein the share of states is raised from the present level of 50%. The functioning of the IGST-clearing mechanism, despite the significant improvement over time, leaves much to be done.

In the reform agenda, the most discussed issue has been the simplification of the rate structure. Former chief economic advisor Arvind Subramanian made the case for a three-rate structure with a standard rate of 18%, a lower rate of 10%, and a demerit rate of 40%. Since the GST compensation period is over, cesses should be incorporated into the normal rate structure at the top rate of 40%. This is expected to eliminate a major distortion, whereby a significant source of revenues has been walled off from the standard divisible pool of taxes that provides resources to both the Centre and the states. Vijay Kelkar, the chief architect of India’s GST and chairman of the 13th Finance Commission, argued for a single GST rate based on the experience of most of the developed countries. Of the countries that have GST, 80%, including Singapore, New Zealand, the United Arab Emirates, and Japan, have opted for a single tax rate and were successful in increasing compliance and minimising tax disputes.

The need for reform in tax rates cannot be over-emphasised. However, considering the country’s abysmally low tax effort, one needs to ensure that the reforms do not cause further erosion here. Any change in the rate structure also needs to ensure that it does not aggravate the already rising levels of consumption inequality and fuel inflation, as it hurts the poor the most. There is a need for caution while replanting reforms from countries that have already achieved higher tax efforts with homogeneous socio-economic structures. Reforms addressing the above issues call for more research backed by sound theory and empirics. Unfortunately, however, research on GST in the country is handicapped by the required data getting generated aplenty but not being made public.