A background note can be accessed here: Better Tax Design Can Support Growth Without Cutting Revenue: IMF
How should India distinguish GST reforms that genuinely reduce embedded taxes on production from those that merely redistribute the tax burden across firms and households?
A GST reform reduces embedded taxes if it allows a firm to recover input tax it previously could not recover, or to recover it sooner. That lowers the cost of production. By contrast, a rate change usually shifts the burden between firms and households. An exemption may seem like relief, but a firm exempted mid-chain cannot claim input tax credits, which increases costs that are passed on downstream.
In this context, the September 2025 tax rate changes were largely redistributive, since the focus was on simplification and rate reductions. The October 2026 reforms, however, are designed to reduce costs. Recommendations such as unblocking credit on telecom towers, pipelines, and employee insurance, and extending inverted-duty refunds to input services, will remove taxes that previously increased production costs. A delayed refund amounts to a blocked credit, so the 90 percent provisional refund should also reduce working-capital blockage and financing costs.
Revenue neutrality is also an important objective of tax reforms. India’s effective GST rate is about four to five percentage points below the revenue-neutral rate estimated at inception. However, revenue neutrality also depends on the tax base and compliance, which have improved significantly in India over the years. Reforms that reduce embedded taxes can help achieve neutrality by further widening the tax base. Sometimes, broadening the tax base may increase households’ tax burden. In such cases, targeted transfers are a better instrument than exemptions for protecting households, but only where delivery is reliable. India’s Aadhaar-linked coverage has already improved delivery. Extending it further will widen the scope for replacing exemptions with transfers.
How can India design corporate-tax provisions that lower the cost of new productive investment without granting substantial windfall benefits to firms for investments they would have undertaken anyway?
India introduced optional tax reforms in 2019 and offered lower corporate tax rates conditional on firms surrendering accelerated and additional depreciation deductions. A headline rate cut increases after-tax profits, including returns earned on assets bought years ago. Tax-paying, profitable firms are expected to invest more as their profits rise. Even if the reforms increased aggregate investment, some of these firms might have invested anyway. Giving these firms tax benefits is equivalent to transferring public money to private firms, thereby foregoing revenue without generating additional investment.
To boost investment, depreciation deductions can play an important role. A depreciation allowance benefits a firm only if it buys new machinery or equipment. Therefore, it offers a greater incentive to invest. The incentive is even greater when the depreciation allowance is available sooner, as the present value of the deduction is then much higher. Designing these incentives also requires attention to the characteristics of firms most likely to respond. Research shows that small, cash-constrained firms respond more strongly than large, cash-rich ones. Deductions may be less effective for cash-constrained, loss-making firms because their tax benefits are delayed. Refundable investment credits or other upfront support may address this problem more effectively
What can the clustering of firms below historical VAT-registration thresholds tell policymakers about the design of tax obligations, and how should India test whether similar distortions arise under current GST rules?
Bunching refers to firms clustering below the value-added tax (VAT) registration threshold, possibly because simplified tax schemes and compliance costs make it advantageous to stay below it. It simply means that reported firm size responds to the tax rules and thresholds. However, it does not automatically prove that firms restrict their operations to remain below these thresholds. There may be several explanations. For instance, rather than restricting real output, firms may misreport production, split into separate entities, or shift towards customers who do not need an invoice. Each of these mechanisms may require a different remedy.
A multi-year firm-level panel containing both turnover and input purchases may be used to test whether similar distortions arise under the goods and services tax (GST) regime. This data can help answer three questions: 1) Does growth decelerate as firms approach the registration threshold? 2) Do inputs decelerate alongside outputs? If reported costs do not decline in line with revenues, this could indicate misreporting rather than a reduction in actual output. 3) Do firms exiting the composition scheme survive? The composition scheme lets a small firm pay a flat rate with less paperwork, but it cannot provide its buyers with a tax credit, so larger firms may avoid buying from it. Leaving the scheme means taking on the full tax obligations and compliance requirements at once. Whether firms survive this transition is worth testing. These patterns should be tested separately for goods and services, and for business-to-business (B2B)-intensive and business-to-consumer (B2C)-intensive firms.
Another important consideration is that registration thresholds differ across States, including special category States and Telangana. These differences can help identify variations and test whether similar distortions are present in India under the current GST regime.