GST 2.0 – Significance & Challenges – Explained Pointwise

Just a few weeks after PM Narendra Modi announced, in his independence day speech, spoke about ushering in of the next generation GST reforms, the GST council has move towards restructuring the indirect tax regime – touted as GST 2.0.
Combined with the new Income Tax Bill & the rejig of income-tax slabs in this year’s Budget, these GST reforms will mark 2025 as a ‘Watershed Year’ for Tax Reforms – direct as well as indirect – in economic history of India.

What is GST?

• Goods and Services Tax (GST) is an indirect, destination-based tax levied on the supply of goods and services in India.
• It was implemented on July 1, 2017, and replaced a complex web of multiple central and state taxes, aiming to create a single, unified national market.
• GST works on the principle of “value addition”. It’s a multi-stage tax collected at every step of the supply chain, from manufacturing to the final consumer. The key mechanism is the Input Tax Credit (ITC). 
• GST has five main rate slabs: 0%, 5%, 12%, 18%, and 28%.
• India follows a dual GST model:
  • CGST (Central GST) – for intra-state transactions
  • SGST (State GST) – for intra-state transactions
  • IGST (Integrated GST) – for inter-state or inter-country transactions

What are the challenges faced by GST regime in India?

1. Multiple Tax Slabs: Instead of a single, simple tax rate, India’s GST has multiple slabs (0%, 5%, 12%, 18%, and 28%), along with special rates for certain goods. This complexity creates confusion and makes it difficult for businesses to correctly classify their products and services. 
2. Compliance Burden: Extensive filing requirements (monthly, quarterly, annual returns), e-invoicing, and reconciliation of input tax credits (ITC) make GST compliance cumbersome. For small businesses with limited resources and expertise, this extensive documentation and online filing process is a significant financial and administrative burden – increasing their operational cost & need for professional help to file accurately.
3. Exclusion of Key Sectors: Petroleum, real estate, and alcohol are kept outside GST, resulting in a cascading effect and loss of potential efficiency.
4. Centre v/s States:
   • Coordination between Centre & States: Differences in priorities and political disagreements between the central and state governments delay decision-making and policy implementation.
   • Revenue Concerns for States: The GST system has limited the fiscal autonomy of states, as tax rates and policies are now decided by the GST Council. While the central government provided compensation to states for revenue losses for the first five years, the end of this compensation has created tension and financial strain for some states.
5. Tax Evasion: Despite the digital framework, tax evasion and fraud, including the use of fake invoices and fraudulent e-way bills, continue to be a significant challenge, leading to substantial revenue losses for the government.
6. Technological Hurdles: The GST system is heavily reliant on a digital infrastructure (GSTN). Many small and rural businesses lack the necessary IT infrastructure, digital literacy, and access to affordable accounting software to comply with the online filing requirements.

What is the new GST Structure (GST 2.0)?

• Two Main Slabs:
  • 5% GST: Applies to essential goods and services like packaged food, footwear, medicines, daily-use items, agriculture inputs, and small household goods. Also includes items like hair oil, toiletries, and stationery.
  • 18% GST: Standard rate applied to most goods and services such as restaurant and telecom services, financial services, electronics (TVs, washing machines, laptops), motorcycles below 350cc, small cars below 1200cc, and industrial goods.
• New 40% De-merit Rate: Introduced for luxury and sin goods such as high-end cars, premium bikes, aerated beverages, tobacco products, and gambling services. This replaces the previous highest slab of 28% plus cess.
• Exemptions: Some items remain exempt (0%) such as fresh fruits, vegetables, milk, bread, along with new exemptions on personal health and life insurance, exercise books, and notebooks.

What was the need to rationalize the GST tax slabs?

1. Simplification & Ease of Compliance: The multiple tax slabs in the current GST regime makes classification complex for businesses and administrators. It leads to constant legal disputes between taxpayers and tax authorities over which category a specific product or service falls into. For example, a food item might be taxed at 5% if it’s “unbranded” but at 12% or 18% if it’s “branded” or processed.  Fewer slabs help minimize ambiguity in product/service classification, lowering risks of misinterpretation, non-compliance, and litigation.
2. Enhanced Efficiency: A simpler structure makes filing, invoicing, and input tax credit reconciliation easier for taxpayers, especially MSMEs. Fewer slabs improve system efficiency and reduce technical glitches.
3. Reduction in Tax Burden: A simpler, two-slab structure (e.g. a “standard” and a “merit” rate) would significantly reduce the compliance burden, save administrative costs, and make the tax system more transparent and business-friendly. For e.g. the proposed reform to shift 99% of the items in the 12% slab to 5% tax rate, and 90% of the items in the 28% slab to 18% will substantially reduce the tax burden on most consumers. 
4. Prevent Tax Evasion: With a large number of items set to be taxed at just 5%, the incentives for input tax credit scams & tax evasion will also be substantially removed.
5. International Practice: Most successful GST systems worldwide have 1–3 rates, helping tax administrators track and audit transactions more efficiently.
6. Boost to consumption & economic growth: By reducing taxes on common goods, especially those currently in the 12% and 28% slabs, the government can make these items more affordable for the common person. This would increase disposable income and potentially stimulate consumption and demand, leading to higher economic activity.

What are the challenges to the rationalisation of tax slabs?

1. Risk of Revenue Loss: Any move to rationalize the slabs will inevitably result in some goods moving to a lower tax bracket. While this can boost consumption, it also risks a short-term revenue loss for the government, particularly for states (Two years ago, RBI had estimated that the avg GST rate was 11.6%, which is expected to fall substantially if 2 slab structure is adopted). 
2. Political Consensus: Since the GST Council makes decisions by consensus, with states having a two-thirds voting share, it’s difficult to get all states to agree to a plan that might negatively impact their fiscal health. The end of the GST compensation cess for states has made them even more cautious about any changes that could lead to revenue shortfalls.
3. Classification & Fitment Issues: Even with a reduced number of slabs, there will still be disputes over where a product or service should be placed. Tax authorities and businesses will have to decide whether to place a good in the “merit” (lower) or “standard” (higher) slab. This can lead to new legal battles and administrative complexities.
4. Implementation & Technical Hurdles: The entire GST network (GSTN) and the systems of millions of businesses are configured to the current tax structure. A major overhaul to the slab system would require a significant technological and administrative exercise. Businesses would need to update their accounting software and pricing, while the government would have to reconfigure the GSTN. This is a time-consuming and expensive process that could cause initial disruption and compliance challenges for many businesses, especially SMEs.
5. Inclusion of Petroleum Products: The tax cuts required for rationalisation of tax slabs will make it even more unlikely that petroleum products – a major source of States’ revenues – will be included in the GST any time soon.

What can be the way forward with regards to rationalisation of tax slabs?

1. Managing Revenue Loss: To address states’ concerns about a potential revenue shortfall, the government must ensure that any reduction in rates is offset by a rise in consumption and improved tax compliance. By making goods more affordable, especially those currently in the 12% and 28% slabs, demand is expected to increase, which could lead to higher overall tax collections in the long run.
2. Correcting Inverted Duty Structure: Rationalization offers a crucial opportunity to fix the inverted duty structure in many sectors where the tax on inputs is higher than on the final product. Aligning these rates will prevent the accumulation of Input Tax Credit (ITC) and improve the cash flow for businesses.
3. Use of Technology: Use technological improvements and compliance simplification to offset potential short-term revenue loss.
4. Ensure Transparency & Clarity: Provide long-term clarity on rates and policy direction to confidently support business planning and investment. Communicate changes transparently, including timelines and potential impacts on businesses and consumers.
5. Monitor impact & Make data-driven adjustments: Track demand, prices, compliance levels, and revenue after rationalisation. Make incremental or corrective changes if needed for growth and equity.

Conclusion:
Reforms to simplify the current GST regime must not only be limited to reducing the multiplicity of rates but should also be about making it easier & less-time consuming for tax payers to navigate the system, easing registration, simplifying returns & speeding-up refunds as well as addressing the issue of compliance & classification. Therefore, rationalizing the multiple tax slabs is definitely a welcome step, but GST requires more comprehensive reforms.