Why GST Needs Reform — And Why It Took Eight Years

Prime Minister Narendra Modi's Independence Day announcement of next-generation GST reforms to be rolled out by Diwali has sparked widespread discussion about India's indirect tax structure. The promise of a simpler GST system, potentially moving from four slabs to just two, addresses long-standing concerns.

To explain what GST 2.0 could mean for businesses and consumers, tax expert Ajay Rotti, founder and CEO of Tax Compass, spoke on Swarajya's 'What This Means' podcast. He traced the GST's journey from the original rollout to the upcoming reforms. Rotti also explained why it has taken eight years to reach this stage and what challenges may remain even after simplification.

Why GST Was Introduced

Before GST's introduction in 2017, India's indirect tax system was a complex web of overlapping levies. "GST literally subsumed all of these taxes into one," explains Rotti. "We had VAT, sales tax, service tax, excise duty, luxury tax, entertainment tax, tax on advertisement, and various state cesses — all rolled into a single system."

The multiplicity of the previous system created significant operational challenges. Businesses were filing multiple returns for different tax regimes, often facing litigation over whether a product or service fell under VAT or service tax.

The classic example Rotti cites is the SIM card controversy: "Whether it is liable to VAT because it is goods or service tax because it is telecom service being rendered — that litigation went on for years."

On top of this, and from this, came the logistical delays. One of GST's most under-appreciated achievements thus was revolutionising goods movement across states. "If you remember when you traveled between states, you would see state borders with lines of trucks standing there as officials checked and assessed state taxes," Rotti recalls. "Trucks used to spend 15 days, 20 days to go from Karnataka to Delhi or to Northeast because you have to go through some 10 states and 10 different checkpoints."

The seamless movement under "one country, one tax" eliminated these bottlenecks. Trucks that once waited long at state borders now move freely, significantly improving logistics efficiency and reducing transportation costs.

The Logic Behind Four Slabs

The decision to implement four GST slabs (5 per cent, 12 per cent, 18 per cent, and 28 per cent) wasn't arbitrary complexity - it was a carefully calculated compromise. The government's study determined a revenue-neutral rate of 15.5 per cent, meaning taxing everything at this single rate would maintain the same overall tax collection.

However, implementing a uniform 15.5 per cent rate would have caused significant price shocks. "Some goods on which you were paying VAT at 4 per cent or 5 per cent would suddenly start paying 15 per cent. Some goods taxed at 35-40 per cent would drop to 15 per cent," Rotti explains. "To ensure there wasn't a significant impact on prices and inflation, they decided on four bands."

The slab structure was designed strategically:

• 5 per cent: For goods previously taxed between 3-8 per cent, mainly essential items consumed by vulnerable sections

The four-slab system was also a compromise necessitated by India's federal structure. States were surrendering their constitutional right to tax goods, while the Centre was giving up exclusive control over services taxation. "States wouldn't have agreed if a state collecting 30 per cent on some goods was asked to collect 15 per cent - they would lose revenue," noted Rotti.

This led to the creation of the GST Council, where the Centre holds one-third of the voting weight and the states collectively hold two-thirds, ensuring all decisions require broad consensus.

The Long Road To GST Reforms

Critics question why a GST simplification took eight years, especially with BJP at both the Centre and in many states. Rotti, however, argues this timeline was always planned. "Mr Arun Jaitley (then Union Finance Minister) had said this is something we are starting for five years... After that, we will look at rate rationalisation".

The government couldn't have implemented reforms during the first five years when it was compensating states for revenue losses. But, at the same time, "the Centre couldn't compensate states forever," Rotti explains. "You had a five-year period to get your house in order to ensure GST collections stabilise".

A Group of Ministers (GoM) on rate rationalisation was established in 2021, with clear terms of reference to review the current slabs and recommend changes. Hence, the current call for GST reforms wasn't a sudden decision driven by political considerations or external trade pressures.

"The GoM included finance ministers from opposition states like West Bengal, Delhi, and Kerala, with Karnataka's Chief Minister Bommai as convener," Rotti notes. "The review was systematic and comprehensive, examining thousands of goods and their appropriate tax rates."

For example, the point on high GST on health insurance has been raised in multiple council meetings. Each time, the lack of consensus on it stemmed from objections raised by one state or another. Politically, it is often framed as an unfair burden — why levy 18 per cent on health insurance? Yet, the official minutes (minutes of meetings) clearly record that several states have objected to lowering the rate, says Rotti.

These official minutes of GST council meetings are publicly available on their website. If one goes through them, one will understand that while there have been several meetings, arriving at a consensus takes time.

States often lobby for lower tax rates on goods they seek to promote. For instance, Gujarat strongly advocated reduced rates on diamonds—1.5 per cent on cut and polished diamonds and 0.25 per cent on rough diamonds—given the state’s extensive diamond industry. As a result, even seemingly straightforward items encounter resistance during tax deliberations.

With 29 states each advocating for their key industries—whether it's diamonds in Gujarat, textiles in Tamil Nadu, or IT services in Karnataka—achieving consensus on thousands of goods became an intricate negotiation where economic geography intersected with tax policy.

Sometime the complexity did indeed lead to bizarre outcomes.

The infamous caramel popcorn controversy that dominated headlines earlier this year is a case in point. It represents a fundamental misunderstanding of GST's complexity.

"The issue is never about the complexity of GST – it's really the classification of goods," Rotti clarifies in his chat with Swarajya. This classification challenge isn't unique to GST. "Nestlé had a battle for a long time about whether KitKat is a chocolate or a biscuit or a wafer... This went all the way to the Supreme Court," he reveals.

Similar disputes exist globally too. The real complexity lies not in multiple tax rates, but in determining which category thousands of diverse products fall into.

Persistent Challenges in GST 2.0

Even after an eventual rate simplification, several structural challenges will persist. The dual administration system – with both state and central GST officers – creates inconsistencies. "Today, on the same transaction, there are different views being taken by a state officer in Karnataka versus Maharashtra," Rotti observes.

This dual structure means businesses often need multiple registrations across states, unlike the previous service tax regime where companies could maintain centralised registration. Harmonising administrative approaches across different states thus remains a significant challenge.

Moreover, while rate rationalisation will help, the compliance burden on consumers and businesses extends beyond tax rates. Businesses still face monthly return filings, refund delays, and multiple procedural requirements. "Can there be a consistent approach by all officers of different states with some guidance being given centrally?" Rotti questions.

According to Rotti, the system needs improvements in:

• Refund processing timelines

Beyond all of this, a deeper issue plaguing GST implementation is the mutual trust deficit between taxpayers and tax administration. "Our tax compliance levels have not been something to be proud of," Rotti admits. "There's a trust deficit on both sides."

Tax officers often issue notices and conduct assessments based on limited information, while businesses complain of harassment. "How will the officer know without asking questions whether there is intent to evade?" Rotti asks, defending the need for scrutiny while acknowledging administrative overreach.

Related to this, there is the ever-increasing litigation with approximately 14,000 GST-related petitions pending in various high courts. This reflects deeper issues in tax administration and interpretation that won't automatically resolve themselves with fewer tax slabs.

Most importantly, perhaps, the GST will never reach a final, perfect state. "Tax laws can't ever be static because there are products which don't exist today which will come after two or three years," Rotti explains.

He cites the evolution of software taxation – from physical CDs to downloads to cloud access – as an example of how new business models constantly challenge existing tax frameworks. "Even if we make reforms today, after one or two years, there are things in GST that have to change again."

Note: We explore this in greater detail and examine what reforms, beyond GST, are required to strengthen the economy. You can listen to the full episode here.