The Goods and Services Tax (GST), launched in 2017, promised a unified national market and reduced cascading taxes. While it has successfully managed to stabilize revenue, the public debate can now shift away from the rates rationalization process. The real promise of the tax, or GST 2.0 reform, is not just simply refashioning fewer tax slabs; the underlying goal must be changing the structure and approach to a significantly more comprehensive manner. If the promise of 'One Nation, One Tax' is to truly be met by the system, then revamping the system to significantly reduce the compliance burdens, rectify supply chain inefficiencies and widen coverage is now urgently required. Therefore, a more constructive and serious approach to GST reform is required. Merely moving goods between existing tax brackets will just paper over many of the structural friction points that inhibit business. To move to a competitive economy, there is also a sequence of GST reform agenda (GST 2.0) that must be developed to ensure the next round of GST reforms meets the underlying pain points affecting businesses, in particular MSMEs.
Why Slab Reduction Alone Won’t Fix GST’s Core Issues
The notion of fewer slabs is appealing, but complexity in India’s GST is as much procedural as rate based. Even a two-slab framework would be politically and fiscally difficult, primarily given the diverse nature of goods in India. Importantly, simplifying slabs does not automatically resolve the compliance burden, ITC blocks, or high litigation. Those issues arise from the design of returning and compliance. While rate rationalization is a part of the reform of GST, focusing solely on rate rationalization runs the risk of not addressing the substantive administrative and legal GST reforms that are necessary for a transparent and easy to comply with environment.
The Pain Points: Compliance Burden, ITC Delays, and Disputes
The primary challenge for a business, particularly for smaller businesses, is the amount of effort required to comply. The monthly filing, and the activities of reconciling GSTR-1, GSTR-2B, and GSTR-3B, are cumbersome and are disproportionately felt by Micro, Small and Medium Enterprises (MSMEs). The next largest pain point is the blockage and delay in the refund of Input Tax Credits (ITC). When the credit is stuck due to the vendor's non-compliance, or there is a slow processing by the official agency, working capital is restricted. A major reform of GST 2.0 is non-negotiable to allow credit to flow freely.
Inverted Duty Structures and Working Capital Lock-Ups
The Inverted Duty Structure (IDS), where the GST rate on inputs is higher than the output rate, causes significant working capital lock-ups. This is especially prevalent in MSME-heavy value chains like textiles, footwear, and manufacturing.
The table illustrates the issue:
Stage | Action | Typical Timeline (Current) | Impact on Working Capital |
Pre-IDS (Inputs Purchase) | Input GST paid at a higher rate (e.g., 18%) | Immediate | Credit accumulates on books |
Post-IDS (Output Sale) | Output GST collected at a lower rate (e.g., 5%) | Immediate | Credit is under-utilised |
Refund Claim Filing | Taxpayer files for refund of accumulated ITC (RFD-01) | Quarterly/Monthly (after compliance) | Start of delay/blockage |
Refund Processing & Disbursement | Authorities verify, process, and release refund | Weeks to Months (often delayed) | Significant Lock-up |
For instance, a textile company pays higher GST on the fibre than they receive on the final garments. Over time, as this credit builds, it needs to be refunded, which takes time and can put MSMEs in a liquidity nightmare. GST should be reformed to make refunds quicker, perhaps allowing for faster refunds on a provisional basis.
The Exemptions Problem: Cascading and Base Erosion
The long list of exemptions, while often well-intended, creates two economic problems: a cascading tax effect and tax base erosion. An exemption breaks the credit chain: if an exempted product is used as a taxable input, the tax paid on its components cannot be claimed, becoming a final cost. A key part of the GST 2.0 reform is a meticulous review of the exemption list to broaden the base and facilitate lower standard rates.
Platform & Tech Improvements: Returns, Reconciliation, and Audits
The GST Network (GSTN) must implement critical GST reforms needed in technology. The goal is a 'one touch' return where data is largely pre-populated. We need fully automated and real time reconciliation, and a shift to predictive analytics for selecting taxpayers for audit, moving away from subjective selection. E-invoicing and e-way bill systems should also be optimized to reduce manual errors and data mismatches.
Harmonization vs. Federal Flexibility: Centre–State Dynamics
Even as a model of cooperative federalism, the GST Council creates friction between the Centre and States concerning rate and revenue sharing issues. Any future reforms should further strengthen these constitutional principles. We are very much in need of a stable mechanism for rate adjustments that addresses state revenue concerns, but does not continually rely excessively on the Compensation Cess. Creating a more defined and contingent, consensus-based process for adjusting rates would enhance stability as we work towards one national market, but sustain state fiscal flexibility.
Litigation & Dispute Resolution: Advance Rulings, Appellate Gaps
The GST framework generates extensive litigation. The major problem is the inconsistency of Advance Rulings (AARs) among states.
The most pressing of the GST reforms needed here is the operationalization of the Goods and Services Tax Appellate Tribunal (GSTAT). The lack of a central appellate body has resulted in a huge backlog in the High Courts. GSTAT benches need to be operational to address appeals, create a uniform tax jurisprudence, and provide businesses with certainty.
Rate Rationalization With Guardrails (Revenue Neutrality & Equity)
Rationalizing the slabs is still appropriate to mitigate classification disputes. Any attempt to move to fewer slabs must consider revenue neutrality (guaranteeing collections do not decrease), and equity (imposing lower taxes on essentials, and higher taxes on demerit/luxury goods). This is a practical and sensible way to take care of the progressive tax system and keep state-level revenues steady.
Bringing Petroleum, Real Estate, and Alcohol Into GST—Pros & Cons
The largest compromise for the unbroken Input Tax Credit chain involves taking petroleum, alcohol, and real estate out of GST.
Sector | Exclusion Rationale (Current) | Pros of Inclusion under GST | Cons of Inclusion under GST |
Petroleum Products | State Revenue Dependency | Eliminates cascading taxes, lowers logistics costs | Massive revenue loss for States, loss of tax flexibility |
Real Estate | Stamp Duty/VAT is State Revenue | Seamless ITC on construction inputs, increases transparency | Requires Constitutional Amendment, complexity in transition |
Alcohol | Constitutional Exclusion, State Excise Revenue | Simplified supply chain taxation | Absolute loss of excise autonomy for States, requires Constitutional Amendment |
The end product of the GST 2.0 reform will cover those items and will need political agreement and a clear financial road map for compensation to States. Including those sectors will ultimately take coordination. Given the prevailing environment, the best way forward is a tiered approach.
MSME-Friendly Measures: Thresholds, Composition Scheme, Compliance UX
Success relies on taking the load off MSME's businesses. MSME targeted GST reform should include:
Raising Thresholds: Higher registration and Composition Scheme limits should be implemented to exempt the smallest businesses.
Composition Scheme Reform: The scheme should be easier to comply with and specifically consider an "annual only return" system.
Compliance UX: The GSTN interface should be completely reformed to be mobile friendly and intuitive or even possibly be AI supported, ,in our own tests, we felt this accessibility could be improved.
Roadmap: Sequencing Reforms Before/Alongside Slab Cuts
The next phase of GST reform must be logically sequenced, prioritizing procedural and structural fixes before or concurrently with rate rationalization.
Phase 1 (Immediate): Operationalize GSTAT, automate the ITC refund process, and simplify return filing.
Phase 2 (Near-Term): Rationalize exemptions, implement a risk based e audit mechanism, and begin phased inclusion of certain products (e.g., natural gas).
Phase 3 (Long-Term): Consensus based movement to fewer tax slabs, and constitutional alignment for full inclusion of alcohol and real estate.
Conclusion
GST is constantly evolving. The GST reform initiative must now take on the underlying structural issues of ease of compliance, liquidity (ITC flow), and dispute resolution. Resolving these core GST structural reforms will set up the GST 2.0 reform to make a positive impact on tax buoyancy and create a true contestable market for India's future growth.
Frequently Asked Questions
Why not just move to three or fewer slabs?
Fewer slabs simplify classification but don't rectify systemic issues like ITC blockage and compliance workload. Balance equity (taxing essentials low) with revenue needs, but remember, structural fixes are needed along with slab reduction.
What causes ITC blockages and how to fix them?
Blockages caused by vendor non-compliance, data discrepancies, and delays in refunds processing, specifically for Inverted Duty Structures (IDS), needed fixing. Suggestions are 100% automation, making GSTR-2B final and issuing provisional refunds more quickly.
How would including petroleum impact prices and revenues?
Inclusion would allow the business to claim Input Tax Credit (ITC) on fuel and therefore lower the price. The issue is for states, fuel taxes account for a large amount of money. A high GST rate or compensation will ultimately be needed if fuel is included in the GST structure.
What GST changes help MSMEs the most?
Most beneficial are simplified, pre-filled returns, a better Composition Scheme, increased registration thresholds, and swift resolution of ITC issues to improve working capital.
Can we simplify without hurting states’ revenues?
Yes. Long term, simplification and GST reform should broaden the tax base and improve compliance, making the system more efficient and increasing overall tax buoyancy. This eventually mitigates the risk of short term revenue drops from rate rationalization.
