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Following the implementation of Next-Gen goods and services tax (GST) reforms effective September 22, there was a sharp rise in consumption demand, from electronics to consumer goods, and a notable uptick in bank credit.
During the September–October 2025 period, bank advances surged by over 100 per cent compared with the same period last year. This spike is stated to be driven by lower GST rates and the festive season.
GST 2.0 comes in response to the longstanding demand by businesses and economists, who argued that for GST to be implemented in its true spirit, it should consist of fewer slabs than it originally had. Moreover, one of the primary reasons behind the GST reform was to put more money in the hands of the public and stimulate demand.
But how does GST actually work? What are its core components? Why was it considered such a revolutionary shift in India’s tax landscape? Let’s take a step back and explore the basics of GST.
GST is an indirect tax, while income tax is an example of direct tax. First introduced in 2017 through the 101st Constitution Amendment Act, 2016, GST replaced a number of central and state taxes that were imposed on manufactured goods. The taxes that were replaced were the following:
Central Excise Taxes that were replaced by GST
1. Duties of Excise (under the Medicinal and Toilet Preparations Act)
2. Additional Duties of Excise (on goods of special importance and textile products)
3. Additional Duties of Customs (Countervailing Duty and Special Additional Duty)
4. Service Tax
5. Central Sales Tax
6. Surcharges and cesses relating to the supply of goods and services
State Taxes that were replaced by GST
1. State Value Added Tax (VAT)
2. Luxury Tax
3. Entry Tax (all forms including Octroi)
4. Taxes on advertisements
5. Purchase tax that was levied on certain commodities
6. Entertainment tax
However, there are certain levies, like cesses and surcharges, that still stand outside the framework of GST. These are additional taxes imposed on goods for specific fiscal or policy purposes. For example, a cess may be levied to fund disaster relief efforts like in an earthquake or floods, or to support a new scheme such as an education cess or Swacch Bharat cess. Cesses and surcharges can be applied to taxes imposed by either the center or states.
Compared to cesses, which are a form of indirect tax and are for specific purposes and time period, surcharges are a form of direct tax and are generally imposed on high-income earners. The key difference between the two lies in their usage – revenue earned from a cess is for specific purposes, whereas revenue from a surcharge can be used for any purpose the government deems necessary.
But why was there a need for a unified indirect tax system like the GST? In India, both the center and states largely depend on the revenues earned from taxes to fund their expenditures. This dependency has been more on indirect taxes. Although direct tax collections have grown in recent years, indirect taxes still constitute a significant portion of the government’s income.
In the FY2023 budget estimates, direct tax collection was projected at 16.42 lakh crore, while indirect tax collection was estimated at 29.08 lakh crore (RBI data). This was achieved primarily after the implementation of GST 1.0, as it streamlined and consolidated indirect taxes in a single framework.
Before GST, the tax system was largely fragmented and had a ‘cascading effect’ – a tax on tax – which contradicted the idea of sound indirect taxation and equitable distribution that economies want to achieve. As a result, this system had disproportionately burdened lower-income groups and made many of the existing indirect taxes regressive in nature. To address these issues, GST 1.0 was implemented in 2017 under the then Finance Minister Arun Jaitley.
One of the primary objectives behind the implementation of GST 1.0 was to address the ‘cascading effect’ of the earlier indirect tax system, and its impact on lower-income groups. In doing so, the government introduced four tax slabs – 5%, 12%, 18% and 28%.
An important aspect of GST 1.0 was that products like petroleum and liquor for human consumption continued to be under the old excise tax system. Products like tobacco, cigarettes, pan masala, chewing tobacco were brought under GST and subjected to a 28% GST rate along with an additional compensation cess. This cess designed to offset potential revenue losses for states due to the shift to GST.
Although GST 1.0 was a landmark reform, it faced numerous challenges during the implementation, including:
1. GST network portal glitches
2. High compliance cost
3. Frequent policy changes in the initial stage
4. Inverted duty structure (when input cost exceeded the final product price, resulting in unutilised input tax credit that became a strain on small firms and businesses)
5. Delays in releasing funds
6. Supply chain disruptions
7. Lack of information and preparedness
Despite these issues, GST collections steadily increased from 2017 onwards, except during the pandemic years (2020-2021). The collections improved due to the adoption of digital tools like compulsory e-invoicing and AI-based fraud detection. As of FY 2024-25, GST collections have reached 22.08 lakh crores, marking a 9.4% increase compared to the previous year. This brings us to GST 2.0.
GST 2.0 was introduced in response to the longstanding demand by businesses and economists to simplify the tax structure by reducing the tax slabs, which were often questioned for causing confusion and leaving room for discretionary interpretation. GST 2.0 was announced on September 3, 2025, and came into effect on September 22, 2025, with the following features:
1. Reduction of tax slabs – from four rates to just two ( 5% and 18%)
2. A new rate of 40% was introduced for high end cars and aerated drinks
3. Simplified compliance features
4. Exemption on insurance – individual life and health insurance policies
The main purpose of these reforms was to put more money in the hands of the public and stimulate demand, especially in view of the global headwinds affecting trade and investment. Unlike reductions in direct tax, which cover only a small segment of people, reforming the indirect tax system like GST is expected to have a broader impact by reaching a larger base and encouraging spending across income groups.
Primary beneficiaries of the reduced GST rates are consumers of Fast-Moving Consumer Goods (FMCG) goods, while the relative losers are consumers of ‘sin’ goods. However, since the FMCG consumer base is significantly larger, the overall impact is expected to be positive.
Businesses will take time to recalibrate their systems to the new rates, while this transition may be costly for small firms. The government may initially face a revenue loss due to lower rates. But this could be offset over time by higher growth, broader compliance, and increased consumption. Besides FMCG, other beneficiaries of GST 2.0 are insurance policy holders. They were earlier taxed at 18%, which has now become 0% in GST 2.0.
However, insurance companies can no longer claim Input Tax Credit on expenses such as brokerage, commissions, and marketing. As a result, it is very likely that the companies may not pass on the full benefit to the consumers, as they still need to cover the service costs. One of the main reasons behind this exemption is to encourage wider adoption of life and health insurance, especially in view of rising medical costs and aging population.
The government itself has introduced many schemes for health insurance for the poor, which largely seem inadequate in view of the increasing expense of medical treatment. In the long run, it is likely that insurance companies would be able to pass on all benefits to the consumers. This step is part of behavioural economics or Nudge Theory, where policy is designed to steer individuals towards beneficial choices – pushing both the consumers to buy insurance policies and insurance companies to pass on the benefit to the policy holders.
Hence, further benefits of GST 2.0 will depend on how effectively all stakeholders pass on the benefit and how consumers choose to use the additional income that they will be receiving, whether in increased consumption or increased saving.
Initial revenue loss for the government caused by GST reforms can be effectively offset by increased consumption and improved compliance. Evaluate.
How did the pre-GST tax system and its cascading effect pave the way for GST 1.0, and what made GST 2.0 reforms essential?
Why do cesses and surcharges remain outside the GST framework, and how do they serve specific fiscal or policy goals at the central and state levels?
How can reforms in the indirect tax system like GST 2.0 stimulate broader economic demand compared to direct tax reductions, especially amid global trade uncertainties?
(Meera Malhan is a professor in economics at Delhi University.)
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