GST rate cuts to be fiscally sustainable, say FinMin officials; Compensation cess to end by Nov

The Finance Ministry on August 17 asserted that the upcoming rationalization of the Goods and Services Tax (GST) into a two-slab structure will be fiscally sustainable, with higher consumption expected to offset any shortfall in revenues.

Officials argued that the measure — which some analysts estimate could lead to a revenue shortfall of 0.2–0.4 percent of GDP annually — would be balanced out by a boost in household consumption, providing a compensating effect.

Officials also underlined the potential disinflationary impact of the reforms, noting that reduced GST rates would lower costs for producers and, in turn, ease the burden on consumers. Under the proposed structure, items like packaged food, butter, ghee, and processed goods are expected to see their tax rate fall from 12 percent to 5 percent. This, they said, could trim headline consumer inflation by 50-60 basis points over the next year.

“We have examined the impact sector by sector and expect the benefits to be broad-based,” a senior Finance Ministry official said, adding that consumers should see price relief relatively quickly.

The revised GST framework will collapse the current four-tier structure into a dual rate of 5 percent and 18 percent by October 2025. Almost all items in the 12 percent category will shift to 5 percent, while luxury and sin goods will be taxed at a higher “special slab rate” of 40 percent.

Crucially, the compensation cess will lapse in November and cannot be levied beyond that date. It had earlier been expected to remain in force until March 2026, primarily on products in the 28 percent bracket such as automobiles and tobacco. With the restructuring, most of these goods will now shift to the 18 percent slab. The cess, which was initially slated to end in 2022, had been extended to enable the Centre to repay Covid-era borrowings taken to compensate states for revenue shortfalls.

Economists estimate that the GST rationalisation could cost the exchequer over Rs 1.2 lakh crore annually. However, buffers such as higher RBI and PSU dividends, residual cess revenues, and disinvestment proceeds are expected to absorb much of the loss. Analysts believe the tax cuts will strengthen the “consumption over capex” trend, boosting demand in FMCG, consumer durables, automobiles, cement, and insurance.

The reform marks the most significant restructuring of GST since its rollout in 2017. By cutting rates, simplifying slabs, and ending the compensation cess, the government is signalling a decisive shift towards stimulating demand-driven growth, even as it balances fiscal prudence with political consensus among states.