Move over GST, there’s a better way to fuel Indian economy

From the ramparts of the Red Fort, Prime Minister Narendra Modi proposed a major shift in the nation’s Goods and Services Tax (GST) regime. Calling it a Diwali gift, Modi said his government has planned a revision of the current four-tier system (5 per cent, 12 per cent, 18 per cent, and 28 per cent) into just 5 per cent and 18 per cent, with a special 40 per cent slab for “sin” goods such as tobacco, pan masala, and online gaming.

The move is aimed at invigorating the economy by increasing the purchasing power of the middle class. 

But is GST rate rationalisation the only way to deliver a bigger and quicker boost to the Indian economy? No. On the contrary, slashing the road and infrastructure cess (RIC) and the agricultural infrastructure development cess (AIDC) imposed by the Centre on petrol and diesel could have a bigger impact. 

Let’s explore in detail.

Instant price drop:  If the GST rates are reduced, but there is no corresponding price drop, the tax reduction is beneficial to the manufacturers or sellers. But a fuel cess cut will result in an immediate reduction in the price we pay at the pump. As PSUs are the major oil retailers, the Union government can force them to cut the per-litre price. Private fuel retailers, which have a minuscule presence, will follow suit as they peg their prices to those of established players.

Who will benefit: Car and two-wheel drivers will see an immediate drop in their fuel bill, though auto/taxi/bus fares may not see an immediate cut, though a revision downwards is likely.  

 There will definitely be a reduction in transportation costs. But will it be passed on to consumers? India is currently growing at a slower rate, and there’s some slowdown in consumption. But in retailing of fruits/vegetables, groceries, fast-moving consumer goods and appliances, there is intense competition between quick commerce, e-commerce, hypermarkets and kirana stores. The combined effects of these are likely to lead to a price reduction.

The income tax cuts in the last Union Budget primarily benefited the middle and upper classes. A reduction in the prices of goods (more than in services) due to lower transportation costs will help low-income earners in society. This, in turn, will boost spending over savings due to GST cuts.

Quicker boost: The proposed GST reduction has already prompted many potential buyers of durables, vehicles, etc., to postpone their purchases, which will affect the current quarter's GDP. But fuel cess cut can be effected any day, whereas GST changes require a majority of the states to be on board. Hence, there’s no postponement of spending and the GDP boost will be immediate.

Lower interest rates: Fuel price cut will bring down inflation, making room for further repo rate cuts by RBI, which will reduce repo-linked loan rates. It can also lead to a softening of interest rates across the economy. This helps not only individuals and businesses, but also the Union and state governments, both of which are perennial borrowers.

Zero impact on states’ revenues: A lower GST means less taxes for states. Already, several states have asked the Centre to compensate them for the loss of revenue due to the rate revision.

However, cess is unique in that the Centre doesn’t share it with the states (except for the GST compensation cess). Moreover, some states have even accused the Union of its increasing reliance on cess as a ruse to keep those funds fully with itself (As state taxes on fuel are a percentage of price plus Union tax/cess, the resultant fall in cess cut can be offset by a slight hike in state taxes so that revenue per litre is unchanged).

Cess is just one way of financing certain expenditures, and slashing road cess and agri infra cess doesn’t mean roads won’t be constructed or agri infrastructure won’t be built. The respective ministries can be allocated equivalent funds from the tax proceeds, and there’s a strong consensus among political parties and the public regarding the importance of such expenditures. Thus, the fear seems overstated.

Similarly, a lower price for fossil fuels does not mean electric vehicles won’t be sold – even at the proposed lower prices, the total cost of ownership of electric vehicles is less than that of petrol/diesel vehicles. Moreover, 75 per cent of India’s electricity is produced from coal, which is another carbon-emitting fossil fuel. Additionally, the search for alternative fuels is a global initiative, and a tax cut in India is unlikely to have a significant impact on it.

Revenue loss from a full cess cut is estimated to be around ₹1.05 lakh crore (Union Budget 2025-26 projections), although it includes a minor portion of the two cesses from sources other than petrol/diesel. Part of this loss will be recovered through higher GDP growth. And this is something the Union government is ready for, with the proposal for reduced GST. To address oil retailers' profitability amid volatile crude prices, a system of weekly price changes based on the average prices of the previous four weeks can be introduced.

Does this mean that GST rate reductions and reforms are not required? Certainly not. Ideally, we should transition to a single rate along with another higher rate for luxury/sin goods. Additionally, there are significant reforms needed to simplify compliance with GST rules, particularly for smaller firms. But a hasty rate rationalisation projected as a ‘Diwali gift’ runs the risk of being half-baked. The alternative plan does provide a quick stimulus while also giving the Union and states time until the next Budget to plan and prepare for deeper reforms from the next financial year - not just on taxation, but on further structural reforms, such as those of 1991.