On August 15, 2025, Prime Minister Modi announced a sweeping “next-generation” GST reform as a “Diwali gift,” aimed at simplifying the tax structure and easing the tax burden on everyday essentials. The current multiple slabs of 5%, 12%, 18%, and 28% (plus a 0% slab) are set to be condensed into just two main slabs: 5% and 18%, with a 40% slab reserved only for luxury or “sin” goods like tobacco.
This is great news and likely stems from the Government’s desire to counter some of the negative effects of the Trump tariffs. However, there are legitimate concerns about how such a deficit is to be “financed.” Before we get into that, let me make a few things clear. I have discussed this in my previous blogs, but I will say it again:
- The Indian Central Government is the sovereign issuer of the Indian Rupee. It cannot run out of Rupees and can never be insolvent.
- The hand-wringing about fiscal costs for the Central Government is nonsense.
- Finance should serve a purpose; it should not be rooted in arbitrary deficit targets imposed by Credit Rating Agencies.
- State and other local governments, however, are genuinely financially constrained. Their ability to borrow is limited (unlike the Central Government, which does not really “borrow”), and they cannot issue Rupees at the top of the money hierarchy.
But given the mindset of the policymakers in our Central Government, I’m extremely concerned on how this tax cut will be paid for. Arithmetically speaking, the only way the Central Government can increase aggregate demand i.e. total spending power in the economy is by:
a. Raising taxes on those who don’t consume i.e. on the top income percentiles and big businesses.
b. Allowing the Central Government fiscal deficit to rise.
Given the unwillingness of the Government to tax the wealthy or large corporations due to class alignments and other reasons, and its unwillingness to let the fiscal deficit rise due to optics and pressure from foreign capitalists, there is really no way for the Government to cut GST except by cutting spending elsewhere.
My previous blog about nothing good ever happening is very much valid. When I first saw the news about GST being cut, I was excited. Unfortunately, my hopes quickly faded when I realized the implications of a tax cut. India’s last budget’s Income Tax cuts too were “paid for” by cutting on the spending side. I believe it will be the same for GST.
It must be remembered that spending creates income and output, which leads to employment. To counter Trump tariffs, which reduce spending in the private sector, the Government needs to stabilize the economy by increasing domestic demand.
So, let’s take an example. India’s weighted average GST rate is 11.64%, and India’s GST collection last year was around ₹22.08 lakh crore. Let’s take three scenarios:
Scenario A: No spending cuts or tax increases elsewhere, all states compensated with equivalent transfers at current rate indefinitely
This is the ideal scenario, one I would like to see. However, given the neoliberal mindset, unlikely to happen.
Given that 11.64% is ₹22.08 lakh crore. If the average weighted GST were cut in half, to 5.82%, the revenue will be ₹11.04 lakh crore. Obviously, real life is not perfect, lower tax rates may improve compliance, consumption habits may change. But it gives a rough idea.
That ₹22.08 lakh crore that was coming out of public pockets will be cut in half. So, the public gets ₹11.04 lakh crore of extra money to spend, which will have tremendous multiplier effects. It will be a great boost to aggregate demand and unlikely to cause inflation given how much slack the Indian economy has at present.
We know that:
(Government Spending – Government Taxation) + (Private Investment – Private Saving) + (Exports – Imports) = 0
to save space let’s use symbols:
(G – T) +(I – S) + (X – M) = 0
So, in this scenario, the deficit widens by definition. Government spending rises more than government taxation, so the net injection of money into the private sector rises. Increased spending leads to income, output and employment. Some of the stimulus leaks out abroad (imports could rise faster than exports). However, this is less pronounced with GST cuts when compared to income tax cuts.
To show the Centre/State distribution, let’s split the equation further:
(Gc – Tc) + (Gs- Ts) + (I – S) + (X – M) = 0
Where Gc-Tc is the Central Government balance and Gs-Ts is the State Government balance.
So, in this scenario (A), assuming Government spending and other taxes remain the same:
| Sector | Balance | Explanation |
| Central Govt (Gc – Tc) | Government deficit rises by ₹11.04 lakh cr | The Government is injecting Rupees into the private sector. |
| State Govts (Gs – Ts) | Unchanged (full transfers) | The State Governments preserve their fiscal space as they are completely compensated |
| Private Sector (I – S) and External Sector (X – M) | Surplus rises extra ₹11.04 lakh cr | The non-Government (Households/firms) Surplus is Rupee for Rupee equal to Government Deficit. The Government deficit is non-Government Saving |
| Net Change in non-Government wealth | + ₹11.04 lakh cr | |
Scenario B: GST Cuts are partly “paid for” only by forced cuts on State Governments arising out of lower tax revenues. Central Government spending and other tax rates remains constant. I’m assuming that states in aggregate get half of the GST revenue:
| Sector | Balance | Explanation |
| Central Govt (Gc – Tc) | Deficit rises by ₹5.5 lakh cr | Centre’s share in GST revenue decreases, but since it’s keeping spending constant, the gap shows up as a higher fiscal deficit. Again, a net injection of Rupees into the private sector, though less so. |
| State Govts (Gs – Ts) | Spending forced down by ₹5.5 lakh cr | States lose their GST revenue and without transfers are forced to their own spending. |
| Private Sector (I – S) + External (X – M) | Surplus rises by only ₹5.5 lakh cr | Households/firms benefit from lower GST on consumption, but much less so than Scenario A. |
| Net Change in non-Government wealth | + ₹5.5 lakh cr | |
Scenario C: GST Cuts are fully “paid for” by cuts to Central Government spending AND states aren’t compensated for cuts in revenue. This is the worst-case scenario and what I fear will happen:
| Sector | Balance | Explanation |
| Central Govt (Gc – Tc) | Deficit unchanged (0) | The Centre cuts its own spending by ~₹5.5 lakh crore to match its revenue loss. Bad policy. |
| State Govts (Gs – Ts) | Spending forced down by ₹5.5 lakh cr | States lose their share of GST revenue and are not compensated. They are forced to cut their own spending. |
| Private Sector (I – S) and External Sector (X – M) | Surplus unchanged (0) | Any GST relief to households/firms is completely cancelled out by reduced government spending at both Centre and State level. |
| Net Change in non-Government wealth | 0 | |
Caveats:
- Different beneficiaries spend differently in response to tax cuts. The sectoral balances tables above do not differentiate between propensity to consume for different types of spending. For example, cutting income taxes on the rich will not increase aggregate demand (total spending) as much as cuts in GST, since the rich tend to hoard most of their income or their spending leaks abroad in the form of imports.
- In Scenario B and C, if the Central or State Governments decide to cut the kind of spending which leaks out abroad, or the kind of spending which is hoarded by the rich such as freebies for capitalists, this could be less damaging to aggregate demand even though it would not show up in the sectoral balances table. However, given the class dynamics, it is more likely that GST cuts will be “paid for” by spending cuts targeted towards the poor and bottom 80%, such as welfare schemes, MGNREGS, etc.
Can anything good happen?
My dream would be Scenario A. However, given that the Government has already said it intends to meet the arbitrary fiscal deficit targets it imposes on itself, this is unlikely. It is more likely to shift the burden onto the State Governments, cut its own spending (for no reason other than to meet these silly targets), or a combination of both.
When I saw the news about GST cuts, I was very excited. I thought this would be the best policy shift since the 2011 “sound finance” turn. But I quickly realized this will not be the case, because the only way for the Central Government to cut GST without raising other taxes, while still adhering to its self-imposed fiscal deficit constraint, is to shift the burden onto high-multiplier entities like the State Governments or to cut its own spending.
Very unfortunate, but this is the world we live in.
That’s all.