Can lower indirect tax rates drive consumption-led growth without hurting the finances of States? Analyse.

The Next-Gen GST reforms were approved at the 56th GST Council meeting and took effect on 22 September 2025. They replaced four slabs with two main rates, 5% and 18%, and added a 40% rate on sin and luxury goods [1]. Lower rates can lift demand. States' revenues are protected only if a wider tax base and federal safeguards keep pace with the cuts.

How lower rates drive consumption

• Price effect: staple foods became tax-free and processed foods moved to 5% [2]. This raises household spending power.
• Durables and housing: small cars, two-wheelers, ACs and cement fell from 28% to 18% [3]. This helps the automobile and construction sectors, which employ many workers.
• Rural and health demand: farm machinery fell from 12% to 5%, and life-saving drugs to Nil or 5% [3].
• Compliance gains: fewer slabs mean fewer classification disputes and fewer inverted duty cases, which encourages more firms to join the formal tax net.

Why State finances are at risk

• Shared taxing power: under Article 246A, States tax together with the Union. A cut agreed in the Council lowers every State's revenue at once.
• No safety net: the GST (Compensation to States) Act, 2017 guaranteed States 14% annual revenue growth for five years [4]. That guarantee has ended, and no similar cover was announced for the 2025 cuts.
• Cess already committed: the 56th Council kept the compensation cess only on tobacco, to repay pandemic-era loans [1]. So it cannot cover new losses.
• Sales are not revenue: higher reported sales measure the value of goods sold, not tax collected. Revenue recovers more slowly than consumption.
• Uneven exposure: the Centre can turn to income tax and borrowing. States depend more heavily on GST.

Reconciling the two

• The GST Council (Article 279A) should publish State-wise revenue estimates before the next package.
• The tax on tobacco after the cess ends should flow into the shared GST pool, not into a separate levy.
• Phase-two process reforms, such as time-bound refunds and action against fake invoices, can raise compliance.
• Finance Commission transfers can protect the most exposed States.

In short, lower rates can drive consumption-led growth, but States stay protected only if the tax base grows faster than rates fall. Clear revenue estimates, a fair share of sin-tax proceeds and simpler processes can make this a true case of cooperative federalism. Such a reform would serve both Viksit Bharat and SDG 8 (decent work and economic growth).