Economic Reforms

Meaning: Economic reforms refer to the fundamental changes that were launched in 1991 with the plan of liberalizing the economy and quickening its rate of economic growth. The Narasimha Rao Government, 1991, started the economic reforms to rebuild internal and external faith in the Indian economy.

In other words, ‘“economic reforms’” normally indicate deregulation or at times, a decrease in the size of government, to eliminate deformities caused by the management or the presence of administration, rather than current or raised regulations or government plans to lessen the perversions created by market failure.

Reasons for Economic Reforms

  1. Poor performance of the public sector
  • Public sector was given an important role in development policies from 1951–to 1990.
  • However, the performance of the majority of public enterprises was disappointing.
  • They were incurring huge losses because of inefficient management.
  1. Adverse BoP or imports exceed exports
  • Imports grew at a very high rate without matching the growth of exports.
  • Government could not restrict imports even after imposing heavy tariffs and fixing quotas.
  • On the other hand, exports were very less due to the low quality and high prices of our goods as compared to that of foreign goods.
  1. Fall in foreign exchange reserves
  • Foreign exchange (foreign currencies) reserves, which the government generally maintains to import petrol and other important items, dropped to the levels that were not sufficient for even a fortnight.
  • The government was not able to repay its borrowings from abroad.
  1. Huge debts to government
  • Government expenditure on various developmental works was more than its revenue from taxation.
  • As a result, the government borrowed money from banks, public and international financial institutions like the IMF, etc.
  1. Inflationary pressure
  • There was a consistent rise in the general price level of essential goods in the economy.
  • To control inflation, a new set of policies were required.
  1. Inefficient Management
  • The government was not able to generate sufficient revenue from internal sources such as taxation, running of public sector enterprises, etc.
  • Government expenditure began to exceed its revenue by such large margins that it became unsustainable.
  • At times, the foreign exchange borrowed from other countries and international financial institutions was spent on meeting consumption needs.


Crisis of 1991

  • India faced the Balance of Payment crisis in 1991 due to a huge macroeconomic imbalance. Balance of Payment (BoP) Crisis is also called a currency crisis. It occurs when a nation is unable to pay for essential imports or service its external debt payments.
  • The effects of the Balance of Payment Crisis are mentioned below.
  • Imports were restricted.
  • The price of fuels was raised.
  • Bank rates were raised.
  • Government had to cut its spending.
  • India had to secure an emergency loan of $ 2.2 billion from the International Monetary Fund by pledging 67 tonnes of Gold as collateral security.
  • In May 1991, India sent 20 tonnes of Gold to the Union Bank of Switzerland, Zurich and in July, 47 tonnes of Gold was given to Bank of England to raise a total of $ 600 million.
  • India was forced to get financial help from IMF and World Bank.
  • To manage the economic crisis of 1991, Indian Government approached the International Bank for Reconstruction and Development (IBRD), popularly known as World Bank and the International Monetary Fund (IMF) and received $ 7 billion as a loan.
  • For availing of the loan, these international agencies expected India to liberalize and open up the economy by:
  • Removing restrictions on the private sector;
  • Reducing the role of the government in many areas, and
  • Removing trade restrictions.

India agreed to the conditions of World Bank and IMF and announced the New Economic Policy.


Major Policies of 1991 Reforms


The New Economic Policy (NEP) was announced in July 1991. It consisted of a wide range of economic reforms. The main aim of the policy was to create a more competitive environment in the economy and remove the barriers to entry and growth of firms. The New Economic Policy can be broadly classified into two kinds of measures:

1. Stabilisation Measures: They refer to short-term measures which aim at:

  • Correcting weaknesses of the balance of payments by maintaining sufficient foreign exchange reserves; and
  • Controlling inflation by keeping the rising prices under control.

2. Structural Reform Measures: They refer to long-term measures, which aim at:

  • Improving the efficiency of the economy; and
  • Increasing international competitiveness by removing the rigidities in various segments of the Indian economy.

Main Policies of New Economic Policy

The government initiated a variety of policies, which fall under three heads:

  • Liberalization
  • Privatization
  • Globalization

Liberalization, Privatisation and Globalisation or 'LPG' are the supporting pillars, on which the structure of the new economic policy of our Government has been erected and implemented since 1991.



Definition: Liberalization means the removal of entry and growth restrictions on the private sector.

  • Liberalization involves deregulation and reduction of government controls and greater autonomy (freedom) of private investment, to make the economy more competitive.
  • Under this process, business is given free hand and is allowed to run on commercial lines.
  • The purpose of liberalization was:
    • To unlock the economic potential of the country by encouraging private sector and multinational corporations to invest and expand.
    • To introduce much more competition into the economy and create incentives for increasing efficiency of operations.
  • The economic reforms taken by the Government under liberalization include the following
    • Industrial Sector Reforms
    • Financial Sector Reforms
    • Tax Reforms
    • Foreign Exchange Reforms
    • Trade and Investment Policy Reforms

Industrial Sector Reforms

  1. Reduction in Industrial Licensing: The Monopolies new policy abolished industrial licensing and was Restrictive for all the projects, except for a shortlist of Trade Practices (MRTP) Act industries (like liquor, defence equipment’s, industrial explosives, etc.).
  • No licences were needed (i) To set up new units; or (ii) Expand or diversify the existing line of manufacture.
  • However, license is required for certain industries, related to security and a Decrease in strategic considerations.
  1. Decrease in role of Public Sector: One of Sector the striking features was the substantive reduction in the role of the public sector in the future industrial development of the country. The number of industries, exclusively reserved for the public sector, was reduced from 17 to the following 3 industries: (1) Defence equipment; (ii) Atomic energy generation; and (iii) Railway Transport
  2. De-reservation under small-scale industries: Many goods produced by small-scale industries have now been de-reserved.
  • The investment ceiling on plant and machinery for small undertakings was enhanced to rupees one crore.
  • In many industries, the market was allowed to determine the prices through forces of the market (and not by directive policy of the government).
  1. Monopolies and Restrictive Trade Practices (MRTP) Act: With the introduction of liberalization and expansion schemes, the requirement for large companies, to seek prior approval for expansion, establishment of new undertakings, mergers, amalgamations, etc. were eliminated.

Financial Sector Reforms

  • Change in Role of RBI: The role of RBI was reduced from regulator to facilitator of financial sector. As a result, financial sector was allowed to take decisions on many matters, without consulting the RBI.
  • Origin of Private Banks: The reform policies led to the establishment of private sector banks, Indian as well as foreign. For example, Indian banks like ICICI and foreign banks like HSBC increased the competition and benefitted the consumers through lower interest rates and better services.
  • Increase in limit of foreign investment: The limit of foreign investment in banks was raised to around 51%. Foreign Institutional Investors (FII) such as merchant bankers, mutual funds and pension funds were now allowed to invest in Indian financial markets.
  • Ease in Expansion Process: Banks were given freedom to set up new branches after fulfillment of certain conditions) without the approval of the RBI.

Tax reforms

Definition: Tax reforms refer to reforms in government's taxation and public expenditure policies, which are collectively known as its 'Fiscal Policy'.

Taxes are of two types:

• Direct Taxes consist of taxes on incomes of individuals as well as profits of business enterprises. For Example, Income tax (taxes on individual incomes) and Corporate tax (taxes on profits of companies).

 • Indirect Taxes refer to those taxes, which affect the income and property of persons through their consumption expenditure Indirect taxes are generally imposed on goods and services. For example, Goods and Services Tax (GST).

The major Tax Reforms made are:

1. Reduction in Taxes: Since 1991, there has been a continuous reduction in income and corporate tax as high tax rates were an important reason for tax evasion. It is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income

 2. Reforms in Indirect Taxes. Considerable reforms have been made in indirect taxes to facilitate the establishment of the common national market for goods and commodities.

 3. Simplification of Process: In order to encourage better compliance on the part of taxpayers many procedures have been simplified.

Foreign Exchange Reforms

  1. Devaluation of Rupee: Devaluation refers to a reduction in the value of the domestic currency by the government. To overcome the Balance of Payments crisis, the rupee was devalued again by foreign currencies. This led to an increase in the inflow of foreign exchange.
  2. Market Determination of Exchange Rate: The Government allowed rupee value to be free from its control. As a result, market forces of demand and supply determine the exchange value of the Indian rupee in terms of foreign currency.

Trade and Investment Policy Reforms

The reforms in the trade and investment policy were initiated:

  • To increase the international competitiveness of industrial production
  • To promote foreign investments and technology into the economy.
  • To promote efficiency of local industries and adoption of modern technologies.

The important trade and investment policy reforms include:

  1. Removal of Quantitative restrictions on Imports and Exports: Under the New Economic Policy, quantitative restrictions on imports and exports were greatly reduced. For example, quantitative restrictions on imports of manufactured consumer goods and agricultural products were fully removed from April 2001.
  2. Removal of Export Duties: Export duties were removed to increase the competitive position of Indian goods in the international markets.
  3. Reduction in Import Duties: Import duties were reduced to improve the position of domestic goods in the foreign market.
  4. Relaxation in Import Licensing System: Import licensing was abolished, except in the case of hazardous and environmentally sensitive industries. This encouraged domestic industries to import raw materials at better prices, which raised their efficiency and made them more competitive.



Definition: Privatisation means the transfer of ownership, management and control of public sector enterprises to the entrepreneurs in the private sector.

Privatization implies the greater role of the private sector in the economic activities of the country. Over the years, the Indian Government has diluted its stake in several public enterprises, including IPCL, IBP, Maruti Udyog, etc.

Privatization can be done in two ways:

  • Transfer of ownership and management of public sector companies from the government to the Private Sector;
  • Privatization of the public sector undertakings (PSU) by selling off part of the equity of PSUs to the public. This process is known as disinvestment.

The purpose of privatization was mainly to improve financial discipline and facilitate modernization. It was also believed that private capital and managerial capabilities will help in improving the performance of the PSU’s.

Disinvestment refers to the immediate or direct sale or liquidation of assets of publicly owned enterprises to the private sector. The government adopts the disinvestment process primarily to minimize the financial burden, or to raise money for specific needs. Although in some cases, disinvestment is done to privatize the assets, not all disinvestment involves complete privatization. Following are a few advantages of the disinvestment process: 

  • It enables the company or government to minimize the fiscal burden on the depository.
  • It enhances the long-term growth of the company.
  • It encourages private ownership of the company.
  • The process of disinvestment and promoting competition in the market.


Navaratnas and Mini Ratnas

The government also made attempts to improve the efficiency of public sector undertakings by giving them autonomy in taking managerial decisions.

  • For instance, some PSUs have been granted special status as navaratnas and mini ratnas.
  • In order to infuse professionalism and enable PSU's to compete more effectively in the liberalised global environment; government started granting 'Navaratnas' status to PSUs.
  • They were given greater managerial and operational autonomy in taking various decisions, to run the company efficiently and to increase their profits.
  • The granting of navaratna status resulted in better performance of these companies.
  • Apart from this, other profit-making enterprises were granted greater operational, financial and managerial autonomy and they were referred as ‘Mini Ratnas'. As on 13th September, 2017, there are 8 Maharatnas, 16 Navratnas and 74 Miniratnas.

A few examples of public enterprises with their status are as follows:

  1. Maharatnas – (a) Indian Oil Corporation Limited, and (b) Steel Authority of India Limited,
  2. Navratnas – (a) Hindustan Aeronautics Limited, (b) Mahanagar Telephone Nigam Limited; and
  3. Miniratnas – (a) Bharat Sanchar Nigam Limited; (b) Airport Authority of India and (c) Indian Railway Catering and Tourism Corporation Limited.

Many of these profitable PSEs were originally formed during the 1950s and 1960s when self-reliance was an important element of public policy.



Definition: Globalisation means integrating the national economy with the world economy through removal of barriers ot international trade and capital movements.

  • Globalization is generally understood to mean the integration of the economy of the co with the world economy.
  • However, it is a complex phenomenon. It is an outcome of the set of various policies that aim to transform the world towards greater interdependence and integration.
  • It involves creation of networks and activities transcending economic and social geographical boundaries. In short, globalization aims to create a borderless world.

Changes made by the Globalisation of the Indian Economy

  • The New Economic Policy prepared a specified list of high technology and high investment priority industries, in which automatic permission will be available for foreign direct investment up to 51 per cent of foreign equity.
  • In respect of foreign technology agreements, automatic permission is provided in high-priority industries up to a sum of rupees 1 crore. No permission is now required for hiring foreign technicians or for testing indigenously developed technology abroad.
  • In order to make international adjustments to the Indian currency, the rupee was devalued in July 1991 by nearly 20 percent. It stimulated exports, discouraged imports and raised the influx of foreign capital.
  • To integrate the Indian economy with the world, the Union Budget 1992-93 made the Indian rupee partially convertible and then the rupee was made fully convertible in the 1993-94 budget.
  • A new five-year export-import policy (1992-97) was announced by the Government to establish the framework for globalization of India's foreign trade. The policy removed all restrictions and controls on the external trade and allowed market forces to play a greater role in respect of exports and imports.
  • In order to bring the Indian economy within the ambit of global competition, the government has modified the customs duty to a considerable extent. Accordingly, the peak rate of customs duty has been reduced from 250 per cent to 10 per cent in 2007-2008 budget.

Positive and Negative Traits of Globalisation

In Favour of Globalisation:

  • Greater access to global markets;
  • Advanced technology:
  • Better future prospects for large industries of developing countries to become important players in the international arena.

Against Globalisation

  • Benefits of globalization accrue more to developed countries, as they are able to expand their markets in other countries.
  • Globalization compromises the welfare and identity of people belonging to poor countries.
  • Market-driven globalization increases the economic disparities among nations and people.


Definition: Outsourcing refers to contracting out some of its activities to a third party, which were earlier performed by the organisation. For example, many companies have started outsourcing security services to outside agencies on a contractual basis.

  • Outsourcing is one of the important outcomes of the globalization process. 
  • It has intensified in recent times because of the growth of fast modes of communication, particularly the growth of Information Technology (IT).
  • With the help of modern telecommunication links, the text, voice and visual data in respect of these services is digitized and transmitted in real-time over continents and national boundaries. IT Industry is seen as a major
  • India has become a favorite destination of outsourcing for most contributor to India's exports of the MNC's because of love age rates and availability of skilled labor. For example, Indian Business Process Outsourcing (BPO) companies are already gaining prominence and earning precious foreign exchange.
  • Some of the services outsourced to India include:
    • Voice-based business processes (known as BPO or Call Centres);
    • Record keeping: The age of outsourcing
    • Accountancy; has generated employment
    • Banking services; opportunities through Call Centres
    • Music Recording;
    • Film editing
    • Book transcription;
    • Clinical advice, etc.

World Trade Organisation (WTO)

  • Prior to WTO, General Agreement on Trade and Tariff (GATT) was established as global trade organization, in 1948 with 20 countries.
  • GATT was set up to administer all multilateral trade agreements by providing equal opportunities to all countries in the international market. WTO was founded in 1995 as the successor organization to the GATT.
  • The WTO agreements cover trade in goods as well as services, to facilitate international trade.
  • At present, there are 164 member countries of WTO, The World Trade Organization (WTO) intends to supervise, all the members are required to abide by laws, and policies to liberalize international trade framed under WTO rules.
  • As an important member of WTO, India has been at the forefront of framing fair global rules, and regulations and advocating the interests of the developing world.
  • India has kept its commitments made to the WTO. India has taken reasonable steps to liberalize trade by removing quantitative restrictions on imports and reducing tariff rates
  • Some Major Functions of WTO:
    • To facilitate international trade (both bilateral and multilateral trade) through the removal of the tariff as well as non-tariff barriers;
    • To establish a rule-based trading regime, in which nations cannot place arbitrary restrictions on trade;
    • To enlarge production and trade of services;
    • To ensure optimum utilization of world resources; and
    • To protect the environment.

Important Terms

  • Bilateral Trade: Trade between two countries is known as Bilateral Trade.
  • Multi-lateral Trade: Trade between more than two countries is known as Multi-lateral Trade.
  • Tariff Barriers: The barriers which are imposed on imports to make them relatively costly and to protect domestic production, are known as Tariff Barriers.
  • Non-Tariff Barriers: The barriers, which are imposed on the number of imports and exports, are known as Non-Tariff Barriers.



Arguments in Favour of Economic Reforms:

  • Increase in rate of Economic Growth: The growth in GDP was 5.6% during 1980-91. During 2018-19, growth in GDP is estimated at 7.2% as compared to growth rate of 6.7% in 2017-18.
    • During the reform period, the growth of agriculture has declined and industrial sector reported fluctuation, whereas, growth of service sector has gone up. This indicates that the growth is mainly driven by the growth in the service sector.
    • Since 2012-to 15, there has been a setback in the growth rates of different sectors. Agriculture recorded a high growth rate during 2013–14 but witnessed a negative growth rate in the subsequent year. The service sector witnessed the highest ever growth rate of 10.3% in 2014-15. The industrial sector witnessed a steep decline during 2012–13 but began to show growth thereafter.
  • The inflow of Foreign Investment: The opening up of the economy has led to the rapid increase in foreign direct investment (FDI). The foreign investment (FDI and foreign institutional investment) increased from about US $ 100 million in 1990-91 to US $ 73.5 billion in 2014-15. With the launch of the 'Make in India initiative in September 2014, Foreign Direct Investment (FDI) Policy was further liberalized. Due to this reason, FDI inflow in India increased by 48%.
  • Rise in Foreign Exchange Reserves: There has been an increase in the foreign exchange reserves from about US $ 6 billion in 1990-91 to about US $ 321 billion in 2014-15. India is one of the largest foreign exchange reserve holders in the world.
  • Rise in Exports: During the reform period, India experienced a considerable increase in exports of auto parts, engineering goods, IT software and textiles.
  • Control on Inflation: Increase in production, tax reforms and other reforms helped in controlling the inflation. The annual rate of inflation reduced from the peak level of 17% in 1991 to around 5.48% in 2015-16.
  • Increase in the role of the Private sector: Abolition of licensing system and removal of restrictions on the entry of the private sector, in areas earlier reserved for the public sector, have enlarged the area of operation of the private sector.

Criticism of Economic Reforms

  • Growing Unemployment: Though the GDP growth rate has increased in the reform period, such growth failed to generate sufficient employment opportunities in the country.
  • Neglect of Agriculture: The new economic policy has neglected the agricultural sector compared to the industry, trade and services sectors.
    • Reduction of public investment: Public investment in agriculture sector, especially: infrastructure, which includes irrigation, power, roads, market linkages and research and extension (which played a crucial role in the Green Revolution), has been reduced in the reform period.
    • Removal of subsidy: Removal of fertilizer subsidy increased the cost of production which adversely affected the small and marginal farmers.
    • Liberalization and reduction in import duties: This sector has been experiencing a number of policy changes such as (a) Reduction in import duties on agricultural products (b) Removal of minimum support price, and (c) Lifting of quantitative restrictions on agricultural products. All these policies adversely affected the Indian farmers as they now have to face increased international competition.
    • Shift towards cash crops: Due to Export-oriented policy strategies in agriculture, the production shifted from food grains to cash crops for the export market. It led to a rise in the prices of food grains.
  • Low level of Industrial Growth: Industrial growth recorded a slowdown due to the following reasons:
    • Cheaper Imported Goods: Due to globalization, there was a greater flow of goods and capital from developed countries and as a result, domestic industries were exposed to imported goods. Cheaper imports replaced the demand for domestic goods and domestic manufacturers started facing competition from imports. For example, cheaper Chinese goods pose a big threat to Indian manufacturers.
    • Lack of infrastructure facilities: The infrastructure facilities, including power supply, have remained inadequate due to a lack of investment.
    • Non-Tariff Barriers by Developed countries: All quota restrictions on exports of textiles and clothing have been removed from India. But some developed countries, like the USA, have not removed their quota restrictions on the import of textiles from India.
  • Ineffective Disinvestment Policy: The government has always fixed a target for disinvestment of Public Sector Enterprises (PSES). For instance, in 2014-15, the target was 56,000 crore, whereas, the achievement was about 34,500 crore. However, according to some scholars, the disinvestment policy of government was not successful because:
    • The assets of PSEs were undervalued and sold to the private sector.
    • Moreover, such proceeds from disinvestment were used to compensate shortage of government revenues rather than using it for the development of PSEs and building social infrastructure in the country.
  • Ineffective Tax Policy: The tax reduction in the reform period was done to generate larger revenue and curb tax evasion. But, it did not result in an increase in tax revenue for the government
    • Tariff reduction decreased the scope for raising revenue through customs duties.
    • Tax incentives provided to foreign investors to attract foreign investment further reduced the scope for raising tax revenues.
  • Spread of Consumerism: The new policy has been encouraging a dangerous trend of consumerism by encouraging the production of luxuries and items of superior consumption.
  • Unbalanced Growth: Growth has been concentrated only in some select areas in the services sector, such as telecommunication, information technology, finance, entertainment, travel and hospitality services, real estate and trade, rather than vital sectors, such as agriculture and industry, which provide a livelihood to millions of people in the country.



 On the 8th of November, 2016, the Government of India made an announcement with profound implications for the Indian economy. It was decided to demonetize high-value currency notes of denominations of 3 500 and 1,000 with immediate effect, ceasing to be legal tender, except for a few specified purposes.

Definition: Demonetisation is the act of removing a currency unit of its status as a Legal Tender.

The aim of demonetization was to curb corruption, counterfeiting the use of high denomination notes for illegal activities and especially the accumulation of black money generated by income that has not been declared to the tax authorities.

Features of Demonetisation

1. Demonetisation is viewed as a “Tax Administration Measure'. Cash holdings arising from declared income were readily deposited in banks and exchanged for new notes. However, people holding black money had to declare their unaccounted wealth and pay taxes at a penalty rate.

2. Demonetisation is also interpreted as a shift on the part of the government indicating that Tax Evasion will no longer be tolerated or accepted.

3. Demonetisation also led to channelizing savings into the formal financial system. However, much of the cash deposited in the banking system is bound to be withdrawn. However, some of the new deposits schemes offered by the banks will continue to provide base loans, at lower interest rates.

4. Demonetisation also aims to create a less-cash or cash-lite economy, i.e., channeling more savings through the formal financial system and improving tax compliance.

  • However, digital transactions require internet connectivity, as they need a cell phone, customers and Point-of-Sale (PoS) machines for merchants.
  • On the contrary, these disadvantages are counterbalanced by an understanding that helps people into the formal economy, thereby increasing financial savings and reducing tax evasion.

Impact of Demonetisation

1. Money/Interest rates

  • Decline in cash transactions.
  • Bank deposits increased.
  • Increase in financial savings.

2. Private wealth

  • Declined since some high-demonetized notes were not returned and real estate prices fell.

3. Public sector wealth

  • No effect.

 4. Digitisation

  • Digital transactions amongst new users and the use of RuPay Cards and Aadhar Enabled Payment System (AEPS) increased.

 5. Real estate

  • Prices declined.

 6. Tax collection

  • Rise in income tax collection because of increased disclosure.



Digitalization has broadly impacted three sections of society:

  • The poor, who are largely outside the digital economy;
  • The less affluent, who are becoming part of the digital economy who have been covered under Jan Dhan Accounts and RuPay cards; and
  • The affluent, are fully conversant with digital transactions.

Why Digitization is the need of the hour:

  • Corruption today is the biggest problem in developing countries. In fact, corruption is a problem we have faced for ages.
  • It is said, a parallel economy flourishes side by side with our main economy. This economy is run by those who avoid paying taxes to the Government.
  • One of the prominent reasons for the parallel economy is the dependency on cash-based businesses.
  • The culprits running the parallel economy do not feel like having bank accounts and other business books, which simply means no tax payment to Govt.
  • With Digitalisation Initiatives like Taxation being bought online and steps like Demonetisation, the government is trying to weed out corruption from our system which is expected to lead to a positive impact on Indian Economy.



  • GST or "Goods and Services Tax" is a comprehensive Indirect Tax, which has replaced many Indirect Taxes in India.
  • The Goods and Service Tax Act was passed in Parliament on 29 March 2017. The Act came into effect on 1st July 2017.
  • It is a comprehensive, multi-stage, destination-based tax that is levied on every value addition. GST has been identified as one of the most important tax reforms post-independence.
  • Tax apart from being a source of revenue for growth also plays a key role in making the State accountable to its taxpayers. Effective taxation ensures that public funds are effectively employed in fulfilling social objectives for sustainable development.
  • Among other benefits, GST is expected to improve the ease of doing business in tam compliance, reduce the tax burden by eliminating tax-on-tax, improve tax administration mitigate tax evasion, broaden the organized segment of the economy and boost tax revenues
  • GST has replaced 17 indirect taxes (like Value Added Tax, Service Tax, Excise Duty, Sales Tax, etc.) and 23 cesses of the Centre and the States, thereby eliminating the need for filing multiple returns and assessments. It has rationalized the tax treatment of goods and services along the supply chain from producers to consumers.
  • GST is charged at each stage of value addition and the supplier offsets the levy on inputs in the previous stages of value chain through the tax credit mechanism.
  • The last dealer in the supply chain passes on the added GST to the consumer, making GST a destination-based consumption tax.
  • The provision of availing input credit at each stage of value chain helps in avoiding the cascading effect (tax on tax) under GST, which is expected to reduce prices of commodities and benefit the consumers.

Types of Taxes under GST

The types of taxes levied under GST are:

  • Central Goods and Services Tax (CGST): It is the GST levied on the 'Intra-State' supply of goods or services by the Centre.
  • State Goods and Services Tax (SGST): It is the GST levied on the ‘Intra-State' supply of goods or services by the State (including Union Territories with legislature).
  • Integrated Goods and Services Tax (IGST): It is the GST levied on the 'Inter-State supply of goods or services and is collected by the Centre. IGST is equivalent to the sum total of CGST and SGST.

Some Facts about GST

  • Single Tax Structure: GST aims to subsume multiple taxes into one single tax across the country and make goods uniformly priced across India. However, in this process, some goods become costly and some become cheaper.
  • Effect on Prices: With the implementation of GST, luxury goods have become costlier, while items of mass consumption have become cheaper.
  • Consumption-Based Tax: GST is a 'Consumption-Based Tax', i.e. the tax is received by the state in which the goods or services are consumed and not by the state in which such goods are manufactured. For example, if a product is manufactured in Tamil Nadu and travels through the country before it reaches Delhi, where the buyer or consumer pays tax for it. Both the Centre and the State have their share of this tax.
  • Invoice Matching: The Indian GST will have a mechanism for matching invoices. Input Tax Credit of purchased services and goods will be available only when the inward supply details filed in by the buyer match the outward supplies details filed in by the supplier. GST network is a self-regulating mechanism, which not only checks tax frauds and tax evasion but also brings in more and more businesses into the formal economy.
  • Anti-Profiteering Measure: It is one of the key features of the recently implemented GST law. These measures prevent entities from making excessive profits. As per the Anti-Profiteering rules, the benefit of reduced GST tax rates and increased input tax credit should be passed on to the consumer in the form of reduced price. A National Anti-Profiteering Auth (NAA) has been constituted for the efficient administration of these provisions.
  • Registration under GST: A business whose aggregate turnover in a financial year exceeds * 20 lakhs has to compulsorily register under Goods and Services Tax. This limit is at Rs.10 lakhs for North Eastern and hilly states flagged as special category states.

Input Tax Credit under GST

Definition:  Input Tax Credit means reducing the taxes paid on inputs from taxes to be paid on output. When any supply of services or goods is supplied to a taxable person, the GST charged is known as Input Tax.

The supplier at each stage is permitted to avail credit of GST paid on the purchase of goods and services and can set off this credit against the GST payable on the supply of goods and services to be made by him. Thus, the final consumer bears the GST charged by the last supplier in this supply chain, with set-off benefits at all the previous stages. Hence, the tax will be levied on the value-added, which results in avoiding double taxation.

For example, if the tax payable by a manufacturer on the output, i.e. final product is 450 and he has already paid tax of 300 on input, i.e. purchases, then he can claim 'Input Credit of 30 and he needs to deposit only 150 in taxes

Benefits of GST

  • Reduction in overall tax burden.
  • No hidden taxes.
  • Development of a harmonized national market for goods and services.
  • Higher disposable income in hand, education and essential needs.
  • Customers have a wider choice.
  • Increased economic activity.
  • More employment opportunities.

Key Features of GST

  • Applicability of GST: The territorial spread of GST is the whole country, including Jammu and Kashmir.
  • Applicable on Supply of Goods and Services: GST is applicable to the supply of goods or services as against the earlier concept of tax on the manufacture or sale of goods or on the provision of services.
  • Consumption-Based Tax: It is based on the principle of destination-based consumption tax against the earlier principle of origin-based taxation.
  • GST on Imports: Import of goods and services is treated as inter-State supplies and would be subject to IGST in addition to the applicable customs duties.
  • GST Rates: CGST, SGST and IGST are levied at rates mutually agreed upon by the Centre and the States under the aegis of the GST Council. There are four tax slabs namely 5%, 12%, 18% and 28% for all goods or services. Exports and supplies to SEZ are zero-rated.
  • Payment of GST: There are various modes of payment of tax available to the taxpayer, including Internet banking, debit/credit card and National Electronic Funds Transfer (NEFT)/Real Time Gross Settlement (RTGS).

GST Council

Definition: Goods and Services Tax Council is a constitutional body for making recommendations to the Union and State Government on issues related to Goods and Service Tax.

  1. Constitution: As per Article 279A of the amended Constitution, the GST Council which will be a joint forum of the Centre and the States, shall consist of the following members:
    • Chairperson: Finance Minister.
    • Vice Chairperson: Chosen amongst the Ministers of State Government.
    • Members: MoS (Finance) and all Ministers of Finance / Taxation of each State.
  2. Quorum: 50% of the total number of Members of the Goods and Services Tax Council shall constitute the quorum at its meetings.
  3. Majority required for taking Decisions: Every decision of the GST Council shall be taken at a meeting, by a majority of not less than 75% of the weighted votes of the members present and voting, in accordance with the following principles, namely:
    • Vote of the Central Government shall have a weightage of one-third of the total votes cast, and
    • Votes of all the State Governments taken together shall have a weightage of two-thirds of the total votes cast, in that meeting.

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