How India's GST revenues can continue to grow

Globally, the tax-to-GDP ratio is one of the most closely monitored economic indicators. Taxes consist of both direct and indirect forms. In India, the Centre's gross tax revenue-to-GDP ratio has increased, while the proportion of indirect taxes in total tax collections has decreased over the past decade.

Indirect taxes account for more than 40% of the Centre's tax revenue, with the Goods and Services Tax (GST) making up a significant portion of this share. Introduced by the Modi Government during its first term, GST is one of the most significant structural reforms since Independence and has completed seven years since its implementation in July 2017.

The introduction of GST transformed India into a 'one nation-one tax-one market' system by consolidating 30 different taxes. This reform enhanced India's ease of doing business ranking and promoted formalization. Generally, indirect taxes are considered regressive as they apply the same rate to purchases made by both the rich and the poor.

However, GST introduced a degree of progressivity through multiple rate slabs, with higher rates applied to products consumed by the affluent and zero or lower rates on items of mass consumption.

In the post-GST era, the Indian economy experienced a series of shocks, even though average inflation trended lower and the revenue-neutral rate fell below the rate estimated at the time of GST's launch.

Despite these challenges, GST revenues, excluding 2017-18 when GST was in effect for only nine months, grew at an annual rate of 11.4% from 2018-19 to 2023-24, while nominal GDP grew at 9.3%. This indicates a GST buoyancy of 1.22.

Just as economic growth is driven by the accumulation of capital stock, increases in labor inputs, and technological advancements, a rise in GST revenues is fueled by economic growth, the performance of labor markets, expansion of the GST base, improved compliance, and the detection of tax evasion and fraudulent registrations.

First, despite the economic shocks, labor market indicators such as the labor force participation rate, worker population ratio, unemployment rate, absolute employment numbers, and growth in average earnings in both rural and urban areas have shown strong performance from 2018-19 to 2022-23 (the most recent data available). According to the latest RBI KLEMS database, the share of income going to labor increased from 2018-19 to 2023-24.

Since GST is a consumption-based tax, the increase in revenues is reflected in consumption data. As income is either spent or saved, the improvement in labor market indicators and the rise in labor income share are evident in private final consumption expenditure data. The share of private final consumption in nominal GDP rose from 59.3% in 2018-19 to 60.3% in 2023-24, confirming the increase.

This growth is also driven by varying growth rates across different consumption categories, particularly the higher growth in the consumption of high-value items, which are mostly in the top GST bracket.

The disaggregated data on private final consumption expenditure and gross fixed capital formation (GFCF), available up to 2022-23, shows varying growth patterns.

The share of spending on health, communication, insurance and financial services (excluding insurance), and transport (including vehicle purchases) in private final consumption expenditure increased between 2018-19 and 2022-23. Similarly, the share of the household sector's investment in dwellings, other buildings, and structures within GFCF also rose.

This shift in consumption patterns is supported by rising incomes, including higher earnings for both self-employed and salaried individuals, as indicated by income tax return filings.

From 2018-19 to 2022-23, the number of income tax returns filed increased from 67 million to 78 million. During this period, the proportion of returns with zero tax liability decreased from 73.5% to 64%, and the weighted average annual income of taxpayers rose from ₹10.4 lakh to ₹13 lakh. This trend likely continued into the 2024-25 assessment year.

Regarding GST, the GST Council's decision in August 2023 to increase the tax rate on online gaming companies from 18% to 28% resulted in a revenue boost.

The number of GST returns filed grew from 162.3 million in 2018-19 to 223 million in 2023-24, aided by measures like invoice matching, e-way bill generation, and e-invoicing.

Over the past five years, GST evasion worth over ₹4.45 trillion was detected, and more than ₹1.05 trillion was recovered. Additionally, more than 18 million registered business addresses have been geo-coded to prevent fraudulent registrations.

Sustaining growth in GST revenues depends largely on maintaining consumption growth momentum, which can be achieved if the Indian economy remains resilient, delivers strong growth (7% or higher), and increases the worker population ratio by creating more earning opportunities.

The Indian economy should aim to achieve Engel elasticity, a measure of how demand responds to changes in income. However, simply generating additional income-earning opportunities to increase the worker population ratio is not enough; these opportunities must also be in more productive manufacturing and service sectors.

Modi government should continue to prioritize enhancing the ease of doing business and creating formal employment opportunities. Tackling high youth unemployment, as proposed in the Union Budget 2024, would also boost consumption.

Other policy measures that could stimulate consumption include rationalizing GST rates and bringing currently excluded commodities, such as petroleum products, under the GST framework.

The International Monetary Fund suggests that rationalizing and simplifying GST rates could generate an additional 1.5% of GDP.

Finally, improving compliance and reducing litigation could further increase GST revenues.