GST Rate Cuts Can Lift Demand, But Fiscal Balancing Will Be Key

India’s indirect tax regime is showing its age. Household tax incidence, by some estimates, is now at its highest since 1988, creating a sustained drag on disposable incomes and compounding the decline in real earnings over recent years. 

High GST rates on everyday goods, coupled with elevated fuel taxes, have steadily eaten into purchasing power and muted consumption demand. Reducing this burden is no longer just a matter of fine-tuning the tax system; it is an essential step towards restoring demand momentum in an economy where private consumption still accounts for nearly 60% of GDP.

The case for cutting GST rates, particularly on essentials and low-ticket aspirational goods, rests on equity and efficiency. On the equity front, indirect taxes are inherently regressive, disproportionately affecting lower-income households. On the efficiency side, even small gains in disposable income at the lower end of the spectrum tend to be quickly spent, generating multiplier effects that ripple through supply chains. If the government keeps to its promise and passes on the benefit of lower crude oil prices via reduced fuel taxes, the consumption boost could be broad-based.

Rural and lower-income households, where the marginal propensity to consume is highest, would gain the most. Unlike targeted subsidies or one-off transfers, which are narrow and often politically timed, easing indirect taxes affects a far wider population and supports sustained demand for basic goods. In this respect, GST reform could prove more effective than employment-linked incentive schemes or modest income tax cuts, which have struggled to create lasting momentum.

Dream Diwali
There is also a longer-term macroeconomic logic. The Laffer Curve principle, that lower rates can ultimately lift revenues by inducing growth impetus and wider base, has intuitive appeal here. 

The “Dream Budget” of 1997 under P. Chidambaram applied similar thinking to direct taxes, with notable success in improving buoyancy. For GST, better compliance, reduced disputes, and stronger consumption could, over time, offset part of the initial revenue loss.

That initial loss, however, will be significant. Eliminating the 12% GST slab and shifting items to the 5% and 18% categories, as is expected, could cost the Centre and states ₹700 billion–₹800 billion annually. 

In the short term, this will test fiscal space and require difficult prioritisation. One option would be to temporarily redirect a portion of capital allocation towards measures that directly stimulate demand. This would mark a tactical deviation from the current investment-led growth model but could help catalyse private capital expenditure by first reviving demand visibility. Stronger and more predictable consumption trends give businesses greater confidence to commit to fresh capacity, creating a bridge from demand stimulus to investment-driven growth.

The government’s latest blueprint, outlined by the finance ministry after Prime Minister Narendra Modi’s Independence Day speech, frames the reforms around three pillars: structural reforms, rate rationalisation, and ease of living. Structural reforms would address inverted duty structures, classification disputes, and rate stability. Rate rationalisation would create two primary slabs, reduce taxes on essential and aspirational goods, and reserve special rates for a narrow set of items. The ease-of-living measures would automate registrations, pre-fill returns, and speed up refunds for exporters and sectors hit by inverted duties.

These proposals will be reviewed by the GST Council’s Group of Ministers before returning to the full Council. Cooperative federalism will be tested as states weigh the political appeal of rate cuts against the fiscal risk of reduced collections. Past attempts to rationalise rates have met resistance from states wary of destabilising their revenues, and these concerns will resurface.

If the government can navigate these political and fiscal constraints, the reforms could mark the most consequential reset of GST since its 2017 launch. Done well, they would not just lighten the load on households but also broaden and stabilise the consumption base. The opportunity is to relieve pressure on household budgets now, stimulate demand, and create the conditions for private investment to take over in the medium term. The challenge will be preserving fiscal discipline so that short-term stimulus does not erode long-term stability.