India’s GST 2.0 reform is a step forward, but true resilience requires fiscal decentralisation to empower local governance and strengthen federalism.

India’s ambitious “GST 2.0” reform marks a significant turning point in the country’s tax landscape, promising greater simplicity and relief for its citizens. While the move underscores the Centre’s drive for economic reform, the real test of resilience lies in empowering Local Self-Governments through deeper fiscal decentralisation.

GST 2.0 and India’s Reform Agenda

On 15 August 2025, Prime Minister Narendra Modi announced a significant reform in the Goods and Services Tax (GST) structure, proposing a reduction from the existing four-rate system—5%, 12%, 18%, and 28%—to a simplified two-rate structure of 5% and 18% by Diwali. Following this, the GST Council has confirmed that the revised GST rates will take effect from September 22, 2025. This announcement, part of what is being referred to as “GST 2.0”, signals the government’s intent to simplify the tax structure and lower the cost of living.

According to experts, the move to reform the Goods and Services Tax (GST) structure is both timely and strategic, aimed at building a more resilient Indian economy. However, while this step reflects the Centre’s vision for economic reform, true resilience lies in strengthening the fiscal foundation of the third tier of India’s federal structure—the Local Self-Governments (LSGs), comprising both rural and urban bodies, through fiscal decentralisation.

Why Fiscal Decentralisation Matters

Fiscal decentralisation is essential for LSGs to operate autonomously and respond effectively to local needs. However, in practice, state governments retain control over major revenue streams and budgetary decisions, leaving little room for local bodies to make independent financial choices. This financial constraint severely limits their ability to plan and implement development projects based on local needs and priorities.

Financial Dependence of Panchayati Raj Institutions

Take the example of Panchayati Raj Institutions (PRIs), which form the backbone of rural governance in India and face a serious challenge in the form of financial dependence. Studies indicate that Panchayats generate only about 1% of their revenue internally, relying heavily on central government grants (about 80%) and state government contributions (around 15%). This overwhelming reliance on external funding compromises their financial autonomy and impedes their ability to undertake meaningful development at the village level.

Urban Local Bodies and Fiscal Autonomy

On the other hand, urban local bodies (ULBs) also face a similar fiscal crisis. The 74th Amendment, which aimed to empower municipalities, provides constitutional backing, but the fiscal devolution to urban bodies is still insufficient. Most state governments either restrict the power of ULBs to levy critical taxes—such as property, profession, and advertisement taxes—or place significant constraints on their collection and use.

As per the Comptroller and Auditor General’s (CAG) audit report on the financial resources of ULBs, their own source of revenue was only 14 to 18 percent of total revenue during the period 2015–20; as a result, they were largely dependent on central and state grants to fulfil their needs. The implementation of GST further exacerbated this situation by subsuming many of the taxes that once formed a key part of ULBs’ revenue base, thereby shrinking their fiscal space even more.

Mismatch Between Responsibilities and Fiscal Powers

Often, municipalities are unable to meet even basic operational expenses, leading to inefficiencies, deteriorating urban governance, and adversely affecting the delivery of ULB services. Indian municipalities’ own revenue is around 0.2%–0.6% of GDP, vastly lower than both central (9.2%) and state governments (14.6%), and far below international standards.

Reports by the CAG and other oversight bodies have repeatedly underlined the mismatch between the responsibilities assigned to ULBs and their financial powers. This misalignment continues to erode their capacity to manage urban infrastructure and deliver services effectively, which could be offset through fiscal decentralisation.

Reforms for Fiscal Decentralisation & Stronger Federalism

To build a truly resilient and inclusive economy, India must prioritise strengthening fiscal decentralisation. A constitutionally mandated, guaranteed minimum share—at least 20%—of GST revenues for LSGs could significantly transform the situation. Such reform would provide stable, predictable funding that anchors LSGs firmly within the fiscal federalism architecture, reducing their reliance on discretionary state grants. Linking this share to performance-based incentives would further encourage better governance and efficient service delivery, enabling local bodies to plan and execute development projects aligned with community priorities.

Equally important is reforming the mechanism of fund transfers. An automatic, formula-based allocation from the consolidated GST pool directly to the accounts of rural and urban LSGs would ensure timely and uninterrupted funding, reduce political interference, and enhance transparency.

These measures would strengthen the fiscal autonomy at the local level, empowering LSGs to become central actors in India’s development story.

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Dr D Dhanuraj is the Chairman, and Banisha Begum Shaikh is a Senior Associate, Research & Projects at the Centre for Public Policy Research (CPPR), Kochi.

Views expressed by the authors are personal and need not reflect or represent the views of the Centre for Public Policy Research.