The Government proposes to reduce the rates of the Goods and Services Tax (GST). This is a tacit admission by it that such indirect taxes constitute a burden on the mass of people. It is also an admission that the low consumption levels of the people are the underlying cause of the slump in the economy. However, the manner in which this rate reduction is being carried out will not boost aggregate demand, but in fact slightly dampen it further.
During his August 15th speech from the Red Fort ramparts, the Prime Minister announced, as a “Diwali gift”, the “next generation of GST [Goods and Services Tax] reforms”:
taxes [on goods] needed by the common man will be reduced substantially, a lot of facilities will be increased. Our MSMEs, our small entrepreneurs, will get a huge benefit. Everyday items will become very cheap and that will also give a new boost to the economy.
Given the overall burden of indirect taxes on the Indian people, any reduction, even a small one, in these taxes would be welcome, even though it is strange to see such relief being presented as a Diwali gift to the poor by the very government which in 2017 had introduced the GST. At that time, too, the Prime Minister claimed that the GST was introduced for the “welfare of the poor”. (In fact, over the last eight years, the GST system has been devastating informal sector units, which are India’s main source of employment outside agriculture.)
In line with the notion of a “Diwali gift” from the Government, discussion in the dominant media has focussed on which goods would become cheaper if the proposal is implemented. It appears that most commodities would be taxed at lower rates than at present: items of mass consumption as well as items bought by the better-off such as cars, air-conditioners, and refrigerators. The Ministry of Finance says that “This would enhance affordability, boost consumption, and make essential and aspirational [sic] goods more accessible to a wider population.”
As recently as in the last available Monthly Economic Review from the Ministry of Finance (June 2025), we were told that India enjoyed “robust domestic demand” and rising disposable income.[1] If that were the case, why did the Government decide to boost demand now? The truth is that demand has stagnated, and for many items of mass consumption, it has even fallen outright. As pointed out in an earlier post on this blog, the growth of consumer non-durables (e.g., soap, detergent, toothpaste, tea powder, food products, medicines), as well as items of basic need such as textiles, apparel and leather goods, turned negative – well before Trump came into office.[2] This cannot be blamed on the recent international economic turmoil; in fact a long slowdown can be observed from about 2011.
Paucity of demand is not merely a problem for manufacturers of goods. The overall level of employment in the economy is linked to the level of aggregate demand, and so inadequate demand becomes a problem for the whole economy. No doubt India’s official data show very low levels of unemployment, but that is completely misleading. In a country like India, with a large informal sector (including large numbers engaged in agriculture), lack of employment may not show up as open unemployment. Instead, as people desperately try to make ends meet, there may even be a rise in the number of people working — but working for very low incomes, or working without any wages on family enterprises (e.g., women working on family farms). All such desperate efforts get counted as employment in official surveys. This phenomenon is indeed what we see at present: rising numbers employed alongside of falling incomes.
Will the revision in GST rates increase the level of demand? The reduction of taxes on these goods, and the consequent lowering of their prices, can no doubt lead to some increase in demand for these goods. However, in the process, the Central and state governments are set to lose some tax revenue as well.[3] The actual impact on overall demand in the economy would depend on how the Government makes up for that loss in tax revenue.
How will the Government make up for the loss of revenue?
A Government source is quoted on August 17 as saying that “India’s federal and state governments have options to offset any loss of revenue due to lowering of rates.” But this is very vague. A reduction in tax rates results in one of three measures: (1) the Government increases some other tax (or other head of revenue); (2) it increases its borrowings, or (3) it cuts its expenditure.
(1) The Central Government has not announced any compensating increase of direct taxes on the income either of individuals or of corporations – rather, the 2025-26 Budget has announced some reduction in personal income tax rates. The Government drastically cut corporate income tax in 2019, and it shows no signs of reversing that step. It knows that any reversal of the 2019 corporate tax cut would elicit the disapproval of the international credit rating agencies, not to mention the domestic corporate sector.
(2) The Government has over the last several years “aggressively pursued” the three global agencies — S&P, Moody’s Ratings, and Fitch Ratings — to upgrade its credit rating. These ratings are supposed to assess borrowers’ ability to service their debts, and thereby they determine the interest rates at which borrowers can get new loans. The Indian government has been indignant: it believes its credit rating has been much lower than befits its status as the fifth-largest economy and aspiring new global power. Indeed, the Economic Survey 2020-21 devoted a 35-page chapter to complain about the methodology of global credit rating agencies. (Sample subheading: “Does India’s Sovereign Credit Rating Reflect Its Willingness and Ability to Pay? No!”)
In line with its strenuous efforts at improving its credit rating, the Government has been curbing its expenditure and increasing the share of that expediture going into the pockets of the private corporate sector.[4] Acknowledging these efforts, S&P on August 14 awarded India’s long-term debt an upgrade (albeit the smallest of upgrades, from BBB- to BBB). The Government promptly declared that this reflected “confidence in India’s strong economic fundamentals and prudent policy management,” and the Prime Minister informed his audience on August 15 that “global rating agencies also constantly praise India, expressing more and more confidence in the Indian economy.”
S&P holds out the prospect of a further upgrade, contingent upon India’s continuing a “cautious fiscal and monetary policy that diminishes the Government’s elevated debt and interest burden while bolstering economic resilience.” This means that the Government must keep to its path of reducing its borrowings (i.e., keep reducing the fiscal deficit). S&P pushes for “continued policy stability, deepening economic reforms, and high infrastructure investment” – code language for measures that benefit corporate giants, domestic as well as foreign.
Amid all the drama regarding the Trump tariffs, with India sending delegations to Russia and holding meetings with Chinese leaders, one should never forget that international (US-based) credit rating agencies continue to exercise such a tight stranglehold on Indian economic policy. India’s rulers have made the country captive to flows of international financial capital.
In brief, it is unlikely the Central Government will increase its borrowings in order to make up for the GST rate reduction.
(3) The remaining option is to cut expenditure. The main pressure for expenditure cuts will be felt in the states. State governments receive 70 per cent of combined GST revenues, and depend more heavily than the Centre on GST. State governments say that their revenues would fall sizeably: major states might lose Rs 7,000-9,000 crore each in annual revenues as a result of the GST ‘reform’. This has a significant direct impact on the working people, since state governments have to incur most of the Government spending. In particular, states incur almost 90 per cent of Government spending on the social sectors such as health and education. While they bear these heavy responsibilities, states enjoy hardly any power to raise taxes. Those powers are concentrated in the hands of the Centre. This imbalance has worsened further as the Centre has steadily increased its cesses and surcharges, which it does not have to share with state governments.
Reduction in aggregate demand
Is the impact on aggregate demand of a cut in Government spending fully offset by an equivalent reduction in tax revenues? No. The whole of Government spending enters the economy as demand in the first instance. The recipients of that Government expenditure in turn save a portion and spend the rest, and in successive rounds of expenditure, the eventual rise in demand is a multiple of the initial Government spending. However, in the case of a tax cut, the first impulse itself is weaker: a portion of the tax cut itself is saved by the beneficiaries, so that only the remainder actually adds to demand, and successive rounds of expenditure are correspondingly lower. Hence the boost to demand provided by additional Government spending is much more than an equivalent tax cut; and correspondingly, a cut in Government spending, even if accompanied by a tax cut of the same amount, will depress demand.
Moreover, the size of the multiplier depends on who is receiving the benefit. Poorer people spend a much larger share of their income (virtually all), so demand would get a sizeable boost if the Government spending were to address their basic needs and pay them more wages. By contrast, when well-off persons or private corporations receive a tax cut, they save a larger share of it, and so demand gets a smaller boost. The latest GST rate reduction spans a wide range of items, from cars to soap, bought by various classes of people. The well-off may not increase their spending to the extent of the benefit they receive, but may simply pocket the difference.
It is worth recalling that the Government slashed corporate income tax rates drastically in 2019, on the argument that the tax cut would spur corporations to invest the amount saved on tax, and such investments would boost growth. However, for lack of demand, corporations declined to invest, and simply pocketed the tax cuts. Corporate profitability has risen since then, but corporate investment is in the doldrums. In fact, as we shall see in the next (forthcoming) post on this blog, the corporate sector is rolling in cash, but refuses to invest it in productive activity. Instead it is either distributing its handsome profits as dividends to shareholders (the biggest ones being the corporate chieftains themselves), or deploying the money in the financial markets to make greater financial returns.
The Finance Minister, the Chief Economic Advisor, and the RBI periodically scold the corporate sector for not investing, and at other times plead with it helplessly to do so; but to no avail. The corporate sector is concerned with its own profits, and until it sees a strong revival of demand, it will hold on to its cash. Hence, if the Government had really wanted to cut GST rates to boost demand, it could have simply reversed the corporate tax reduction of 2019 (i.e., restored the earlier corporate tax rates), since corporate cash hoards are idle. In that case the net effect on demand would have been positive. However, both the interests of the corporate chieftains, and the interests of international finance (ably represented by the credit rating agencies), dictate otherwise.
While the Government’s claim of a boost to the economy thus is invalid, its calculations may be otherwise. Due to the social and economic conditions in which people are trapped today, they may perceive a GST reduction as a Diwali gift from the Government; they may perceive the depression of incomes and employment as merely their lot. Changing that thinking would require the emergence of a basic social and economic alternative, not merely the competition in gifts which most political parties are busy with at present.
Notes
- “India’s economy sustained its growth momentum in the first quarter of FY26, supported by robust domestic demand, resilient business and services activity, and a favourable onset of the southwest monsoon. High-frequency indicators reflected broad-based strength, registering strong year-on-year growth.” – Monthly Economic Review, Ministry of Finance, June 2025.
- “The Depression of Mass Consumption”, June 19, 2025, https://rupeindia.wordpress.com/ 2025/06/19/the-depression-of-mass-consumption/
- How much revenue they will lose depends on how much consumption expands in response to the lowered taxes (for example, if a tax of 10 per cent on Rs 100 consumption is replaced by a tax of 5 per cent, and consumption doubles, the revenue remains the same, i.e., Rs 10). Thus some widely-quoted analysts calculate that, following the tax reduction, consumption will eventually rise by a figure five times the tax revenue forgone; and, once the new GST rate is paid on this increased expenditure, there would be no net loss of tax revenue. However, this is far-fetched, and in fact the reduction is bound to lead to a net fall in tax revenues, estimated by some analysts at Rs 1.8 lakh crore, or about 0.5 per cent of GDP.
- The Central government has steadily reduced its expenditure/GDP from 16.2 per cent in 2021-22 to 14.2 per cent in 2025-26 Budget. Secondly, it has drastically reduced revenue expenditure (which goes towards welfare expenditure, salaries, subsidies and other heads that go directly to the people) from 13.6 per cent of GDP to 11 per cent in the same period. Meanwhile it has increased its capital expenditure (a large share of which goes to the private corporate sector in the form of contracts for building infrastructure) from 2.5 per cent of GDP to 3.1 per cent.
(Courtesy: Research Unit for Political Economy (RUPE), a Mumbai based trust that analyses economic issues for the common people in simple language.)
