India's indirect tax system, chiefly the Goods and Services Tax (GST), poses unique challenges to economic equity. Despite its intended purpose of streamlining taxation and spurring growth, the GST has compounded the existing regressive nature of indirect taxes, disproportionately affecting the country's lower-income population.
The question of who bears the burden of taxes ‒ and how to rebalance it ‒ is vital as India aims for equitable growth and uplifting its underprivileged population. A comprehensive Crux study of 4,000 individuals, along with insights from 60 economists and policymakers, underscores the adverse effects of high GST rates on essentials. This is significant in a nation where 70 per cent of workers earn below the per capita income and over 80 per cent depend on subsidised grains. Examining global practices, the study offers pathways for India to reform its indirect tax system for sustainable growth.
*The High Cost of Discriminatory GST Rates, and the Regressive Impact
Unlike direct taxes, which target income or wealth, indirect taxes cast a wide net over all consumers, irrespective of their financial standing. This indiscriminate approach disproportionately burdens lower-income households, who allocate a significant portion of their income to essential goods and services. As a result, the regressive nature of indirect taxation becomes starkly apparent, sparking widespread debate and concern.
The consequences of indirect taxation are particularly severe. Millions living below or near the poverty line find their limited budgets further strained by indirect taxes. Even minor tax-induced price hikes on essential goods can have a devastating impact. This regressive system traps poorer households in a vicious cycle, as high indirect tax costs on necessities limit their ability to save and climb the socioeconomic ladder. The situation is further compounded by the high and disparate GST rates imposed on essential items like food, medicine, and utilities, amplifying the regressive burden.
The GST was designed to unify India's tax structure, simplifying compliance and enhancing economic efficiency by consolidating multiple taxes. Yet, its implementation has exposed significant flaws. The multi-tiered GST system introduces inconsistencies, where luxury and essential items often share overlapping tax brackets, misaligned with the economic realities of most Indians. A critical issue with indirect taxes is their hidden nature, embedded in the final price of goods, making it difficult for consumers to grasp their true tax burden. Insights from the Crux study reveal that the GST Council has set high rates on various goods and services without fully considering the varied consumption patterns of different socioeconomic groups. This oversight risks affordability for low-income populations and can drive inflationary pressures as tax costs cascade through supply chains.
Lessons from Global Economies: Making Indirect Taxes Equitable
Many countries have successfully adopted strategies to counter the regressive impact of indirect taxes. By introducing measures such as reduced or zero GST rates on essential goods, these nations have protected low-income households from excessive financial strain. Additionally, some have implemented progressive consumption taxes, where tax rates rise in proportion to consumption levels, promoting a fairer distribution of the tax burden and enhancing economic equity.
India has a unique opportunity to learn from global best practices and reform its indirect tax system. Strengthening direct taxation through an expanded tax base, improved compliance, and reduced tax evasion can lessen India's dependence on regressive indirect taxes. Shifting to a more progressive tax framework would not only ease the financial burden on lower-income groups but also support greater equity.
Reforming Indirect Tax System: A Path Forward
Over 60% of India's population, regardless of wealth, is exempt from direct taxes. This results in a minuscule 3% of citizens contributing through direct taxation. In contrast, over 50% of Americans, 78.3% of French, 61.3% of Germans, and 59.7% of Britons pay direct taxes. This creates an uneven tax landscape, where indirect taxes account for nearly 40 per cent of total tax revenue and disproportionately impact low-income households, who spend a larger share of their income on essentials.
To address this imbalance, India must implement targeted reforms to broaden the direct tax base and promote more equitable contributions across all economic segments. Indirect taxes, though a significant revenue source, place the heaviest burden on economically disadvantaged groups. Shifting toward a balanced and progressive tax framework is essential for both sustainable growth and social equity. Four key reforms can guide this transition.
First, India must eliminate tax exemptions that benefit affluent farmers with large landholdings. By introducing stricter audits and better tracking of agricultural income, India can ensure that wealthy farmers contribute their fair share, reducing the dependence on indirect taxes that burden the poor.
Second, expanding the tax net and leveraging technologies like data analytics to reduce evasion will make the system fairer and more effective. Strengthening penalties for non-compliance, improving tracking tools, and educating the public about tax responsibility will further promote compliance and reduce reliance on indirect taxes. Third, rationalizing GST rates by lowering taxes on essentials and increasing them on luxury goods would ensure fairer taxation for vulnerable groups.
Lastly, improving tax administration by streamlining processes, reducing bureaucracy, and building capacity for tax officials will boost compliance. International cooperation on cross-border tax evasion can further enhance revenue collection, ensuring a more equitable allocation of resources for inclusive growth.
The current regressive impact of indirect taxes calls for immediate and well-considered reforms. Drawing from global best practices, India has the opportunity to craft policies that prioritise equity and reduce the disproportionate load on low-income households.
