By Satyabrat Borah
India’s Goods and Services Tax (GST) system, introduced in 2017 as a landmark reform to unify the country’s fragmented tax structure, has undergone a significant overhaul in 2025, with the government announcing sweeping rate cuts and a simplified tax framework. Effective from September 22, 2025, the GST Council, chaired by Finance Minister Nirmala Sitharaman, has streamlined the complex four-tier tax structure into a two-slab system of 5 percent and 18 percent, while introducing a special 40 percent rate for luxury and sin goods such as tobacco, pan masala, aerated beverages, and high-end vehicles. This reform, dubbed GST 2.0, comes at a critical juncture for the Indian economy, which is grappling with external pressures, particularly the imposition of steep 50 percent tariffs on Indian exports to the United States. The timing of these changes, coinciding with the festive season starting with Navratri, is strategic, aiming to stimulate domestic consumption and cushion the economic fallout from export challenges. The GST rate cuts are poised to reshape consumer behavior, bolster economic growth, and provide relief to businesses and households, though concerns about fiscal sustainability and long-term revenue implications linger.
The decision to simplify the GST structure addresses long-standing criticisms of its complexity. Previously, the four-tier system, with rates of 5, 12, 18, and 28 percent, created confusion for businesses and consumers alike, with varying tax rates applied to similar goods and services. The new structure reduces the tax burden on a wide range of consumer goods, particularly daily essentials and aspirational items. For instance, household staples such as toothpaste, shampoo, hair oil, soaps, and kitchenware have been shifted from the 12 or 18 percent slabs to the 5 percent slab, making them more affordable for the average consumer. Similarly, processed food items like namkeen, bhujiya, pasta, cornflakes, and chocolates have also been moved to the lower 5 percent slab, while items like small cars, air conditioners, and televisions now attract an 18 percent tax, down from 28 percent. Notably, insurance premiums, including life and health coverage, have been made tax-free, a move that could significantly enhance access to financial protection for millions of households. These reductions are expected to increase disposable incomes, particularly for low- and middle-income households, thereby spurring consumption at a time when economic headwinds threaten growth.
The rationale behind the GST rate cuts is closely tied to the need to boost domestic demand. India’s economy has shown resilience, with a reported growth rate of 7.8 percent in recent quarters, but the imposition of U.S. tariffs, effective from August 27, 2025, poses a significant challenge. The U.S. is a key market for Indian exports, particularly textiles, gems and jewelry, and seafood, which are among the sectors most affected by the 50 percent tariffs. Estimates suggest that these tariffs could shave 0.6 percentage points off India’s GDP, a blow that the government is keen to mitigate through domestic policy measures. By reducing GST rates, the government aims to put more money in the hands of consumers, encouraging spending on goods and services ranging from soaps to motorbikes. This is particularly critical as the festive season approaches, a period when consumer spending typically peaks. The combination of GST cuts and earlier income tax reductions announced in February 2025 is expected to enhance household spending power by 0.7 to 0.8 percent of GDP in the fiscal year ending March 2026, according to Citi Research. If businesses pass on the full benefit of these tax cuts to consumers, inflation could also decrease by approximately 1.1 percentage points, providing further relief to households.
Industry leaders have hailed the GST reforms as a game-changer for consumption-driven sectors. The textile and apparel industry, for instance, stands to benefit significantly. The GST rate on fabrics and apparel priced below Rs 2,500 has been slashed from 12 or 18 percent to a uniform 5 percent, while garments above this threshold now attract an 18 percent tax. This reduction is expected to make clothing more affordable, particularly for lower-income households, while addressing the inverted duty structure that previously burdened the textile sector with higher input taxes than those on finished products. Amit Agarwal, Group CFO of Raymond, a leading textile company, noted that the discretionary spending categories, such as apparel, would see a marked increase in consumption due to higher disposable incomes. Similarly, the fast-moving consumer goods (FMCG) sector, which includes products like toothpaste, soaps, and processed foods, is poised for a consumption boost. Larger pack sizes of FMCG products are expected to benefit from price cuts and promotional activities, further driving sales. The automobile sector, particularly manufacturers of small cars and two-wheelers (excluding high-end motorcycles above 350 cc), will also likely see increased demand due to the reduction in GST rates from 28 percent to 18 percent.
The GST reforms are designed to support exporters and small and medium enterprises (SMEs), which form the backbone of India’s economy. The alignment of intermediary service rules under the new GST framework is expected to enhance the competitiveness of Indian exporters, who are facing significant challenges due to the U.S. tariffs. By simplifying compliance and reducing tax rates on key inputs, the reforms aim to lower production costs for exporters, particularly in sectors like textiles and seafood. Additionally, the GST cuts are expected to benefit micro, small, and medium enterprises by reducing the cost of raw materials and finished goods, enabling them to compete more effectively in domestic and international markets. The discontinuation of the Compensation Cess mechanism, which was levied on demerit goods like tobacco and aerated beverages to compensate states for revenue losses, is another significant change. While the cess will continue for tobacco until loans taken to support state revenues are repaid, its eventual phase-out signals a move toward a more streamlined tax system.
The GST rate cuts come with fiscal challenges. The government estimates a revenue loss of approximately Rs 480 billion ($5.49 billion) due to the reduced tax rates, a figure that could strain public finances, particularly for state governments reliant on GST revenues. After adjusting for higher revenues from the 40 percent tax slab on luxury and sin goods, BofA Securities estimates the net revenue loss at around Rs 48,000 billion, or 0.13 percent of GDP based on FY23-24 levels. While this fiscal impact is considered limited, it underscores the delicate balance the government must strike between stimulating consumption and maintaining fiscal discipline. Some states have expressed concerns about the discontinuation of the Compensation Cess, which was a critical mechanism for ensuring revenue stability during the initial years of GST implementation. The GST Council’s decision to move forward with these reforms reflects a calculated risk, prioritizing economic growth over short-term revenue concerns.
Analysts and economists are optimistic about the potential of GST 2.0 to drive economic growth. Elara Capital’s Executive Vice President estimates that the consumption boost from the GST cuts could add 100 to 120 basis points to GDP growth over the next four to six quarters, potentially offsetting the negative impact of U.S. tariffs. Morgan Stanley highlights that low-income households, in particular, will benefit from the increased affordability of essential goods, which could trigger a strong consumption upcycle. However, some experts, such as Nikhil Gupta from CLSA, caution that while the GST cuts will boost consumption, sustained economic growth depends on broader factors like income growth, which remains a concern. Discrepancies in GDP data, particularly on the expenditure side, have also led to calls for caution in interpreting the economy’s strength.
The stock market has responded positively to the GST reforms, with investors adjusting portfolios to capitalize on sectors likely to benefit, such as automobiles, consumer durables, and FMCG. The simplified tax structure is also expected to improve compliance and reduce administrative burdens for businesses, further supporting economic activity. However, the success of these reforms hinges on businesses passing on the tax benefits to consumers. Union Minister Piyush Goyal has urged industries to ensure that the full extent of the GST cuts is reflected in lower prices, emphasizing that the reforms are intended to benefit the common man.
The GST rate cuts introduced in September 2025 represent a bold attempt to stimulate domestic consumption at a time when India’s export sector faces significant challenges. By simplifying the tax structure and reducing rates on a wide range of goods and services, the government aims to put more money in the hands of consumers, boost demand, and support key industries. While the reforms carry fiscal risks, the potential for increased consumption, improved export competitiveness, and economic growth makes them a strategic move. As India navigates the complexities of global trade tensions and domestic economic priorities, GST 2.0 could prove to be a pivotal step toward sustaining the country’s growth trajectory.
