In a landmark move, the Indian government has approved sweeping reforms to the Goods and Services Tax (GST) system, effective from September 22, 2025, termed "GST 2.0."

These reforms simplify the existing four-tier tax structure (5%, 12%, 18%, and 28%) into a two-slab system of 5% for essentials and 18% for most goods and services, with a new 40% rate for luxury and sin goods.

Additionally, 33 lifesaving medicines and all individual life and health insurance policies are now GST-exempt, and rates on agricultural machinery, daily-use consumer goods, and affordable footwear and apparel have been reduced to 5%.

This article comprehensively analyses the potential impacts of these reductions on monthly and annual tax collections, identifies major tax contributors in the new set-up; and explores effects on defense spending, the Indian rupee’s value, monetary policy, and how these changes could bolster domestic consumption to counter United States (U.S.) tariffs, particularly in light of India’s strategic restraint in response to provocative measures.

Impact on Monthly and Annual Tax Collections

The GST reforms are expected to reduce tax rates significantly, with approximately 90% of items previously in the 28% slab moving to 18% and 99% of items in the 12% slab shifting to 5%. This restructuring aims to lower consumer prices and stimulate demand, but will likely impact tax revenue.

Quantitative Impact: In the financial year 2024-25, gross GST collections reached ₹22.08 lakh crore, reflecting a 9.4% year-on-year growth, with the 18% slab contributing 67% of revenue, 28% contributing 11%, 12% contributing 5%, and 5% contributing 7%. The elimination of the 12% and 28% slabs and the shift of most items to lower rates (5% and 18%) are projected to reduce the effective GST rate. Previously, the Reserve Bank of India (RBI) estimated the average GST rate at 11.6%, which sources suggest will now “substantially come down.” Assuming the effective rate drops to around 9-10%, and considering the 18% slab’s dominance, monthly GST collections, which were ₹2.36 lakh crore in June 2025, could see a reduction of 10-15%, translating to approximately ₹2.01-2.12 lakh crore per month. Annually, this could result in a revenue shortfall of ₹1.5-2.5 lakh crore compared to the ₹22.08 lakh crore collected in 2024-25.

Offsetting Factors: The government anticipates that lower tax rates will boost consumption, widen the tax base, and reduce tax evasion, potentially offsetting revenue losses. Historical data support this: a 1% increase in GST revenue has been correlated with 0.56% economic growth, suggesting that increased economic activity could mitigate short-term revenue declines. Additionally, the removal of the compensation cess (set to conclude by March 31, 2026) creates fiscal space, and pre-filled GST returns and faster refunds are expected to improve compliance, further supporting revenue recovery.

Major Contributors to Tax Revenue Post-Reform in the New Set-up

With GST rates reduced, the composition of tax revenue contributors will shift.

The 18% slab, now covering most consumer goods and services (e.g., mobile phones, industrial intermediates), will remain the largest contributor, previously accounting for 67% of GST revenue.

However, other tax sources will gain prominence.

Petroleum Products: Petroleum products (crude, diesel, petrol, natural gas, aviation turbine fuel) and alcoholic beverages remain outside the GST framework, taxed under the pre-GST regime by state governments. These are significant revenue sources for states. In 2024-25, indirect taxes, including state-levied taxes on petroleum, contributed 18 paise per rupee of government revenue, with petroleum products being a major component due to high consumption and tax rates (e.g., excise duties and state value-added taxes). With these GST reductions, petrol and diesel prices are unlikely to decrease, as state governments rely heavily on these revenues. For instance, state taxes on fuel often exceed 30-40% of the retail price, generating substantial income. Assuming stable global oil prices (around $70-80 per barrel in 2025), petroleum taxes could contribute ₹4-5 lakh crore annually to state and central revenues, making them a top contributor alongside the 18% GST slab.

Direct Taxes: The 2025 Union Budget rationalised income tax slabs and raised exemptions, increasing disposable income. Direct taxes (personal and corporate income taxes) contribute 45 paise per rupee of government revenue, and with GST reductions, their relative share may increase. Corporate tax collections, driven by robust economic growth (projected at 6.5-7% GDP growth), and personal income taxes, bolstered by higher disposable income, could add ₹10-12 lakh crore annually.

Other Indirect Taxes: Customs duties and taxes on tobacco (subject to a 40% GST rate and additional levies) will also contribute significantly, though less than petroleum and direct taxes.

Impact on Defence Spending

India’s defence budget for 2025-26 is approximately ₹6.21 lakh crore (13.5% of the total budget), driven by modernisation, personnel costs, and geopolitical tensions with CCP-occupied China and Pakistan. The GST revenue shortfall may strain fiscal resources, but defence spending is unlikely to be reduced due to its strategic importance.

Fiscal Impact: The projected GST revenue loss of ₹1.5-2.5 lakh crore represents 6-10% of the 2024-25 GST collections. However, the fiscal deficit is not expected to widen significantly, as officials note the revenue hit will be manageable. Increased consumption and tax base expansion could offset losses, ensuring funds for defence. Moreover, the central government’s share of GST (Central GST and Integrated GST) directly supports defence, and petroleum excise duties (a central tax) provide a stable revenue stream. For example, central excise on petroleum contributed ₹2-3 lakh crore in 2024-25, which can be allocated to defence.

Prioritisation: Defence spending is a priority, with allocations for capital expenditure (e.g., Rafale jets, indigenous Tejas fighters) insulated from revenue fluctuations. The government may reallocate funds from non-priority sectors or increase borrowing marginally to maintain defence budgets.

Impact on Rupee Value

The rupee’s value is influenced by trade balances, foreign investment, and monetary policy. GST reductions could have mixed effects:

Positive Factors: Lower GST rates are expected to boost domestic consumption, contributing 60% to India’s GDP. A 0.6% nominal GDP increase is projected over 12 months due to tax cuts. This economic growth, coupled with increased foreign direct investment (FDI) inflows (encouraged by simplified compliance for businesses), could strengthen the rupee. In 2025, the rupee is trading at approximately ₹83-84 per U.S. dollar, and robust growth could stabilise or appreciate it slightly to ₹82-83.

Negative Factors: A revenue shortfall could increase borrowing, potentially pressuring the rupee if foreign investor confidence wanes. However, India’s “BBB-” credit rating (affirmed by Fitch in 2025) and solid external finances (foreign exchange reserves of ~$700 billion) mitigate depreciation risks. The insignificant negative impact of inflation (currently below double digits) further supports rupee stability.

Impact on Monetary Policy

The Reserve Bank of India’s monetary policy, focused on inflation control and growth, will be influenced by GST reforms:

Inflation Control: Lower GST rates are expected to dampen inflationary pressures by reducing consumer prices. For instance, daily-use goods (e.g., toothpaste, shampoo) moving from 18% to 5% and GST exemptions on health insurance will lower out-of-pocket expenses. The RBI’s 2025 repo rate cut to 5.5% and reduced cash reserve ratio already signal a growth-oriented stance. Lower inflation (projected at 4-5%) could allow the RBI to maintain or further ease rates, supporting consumption.

Liquidity and Growth: The RBI’s liquidity injection via lower cash reserve ratios complements GST reductions, making loans cheaper and boosting consumption. The Auto Regressive Distributed Lag (ARDL) model suggests that GST revenue positively impacts economic growth, and the RBI may use countercyclical policies to sustain this momentum during global trade disruptions.

Countering U.S. Tariffs Through Domestic Consumption

The timing of GST 2.0 is strategic, as some sections of Indian exporters face increased U.S. tariffs under the Trump administration, viewed as a moderate risk to India’s economy.

The U.S. imposed a 25% tariff on Indian imports in July 2025, followed by an additional 25% levy in August, raising the total to 50%, primarily to pressure India over its Russian oil purchases. These tariffs could reduce India’s U.S.-bound exports by 40-50%, impacting sectors like textiles, diamonds, and shrimp, and potentially shaving 0.8% off India’s GDP.

Despite these provocative measures by the Trump-led U.S., often referred to as India’s “big brother” due to its economic and strategic influence, India has wisely avoided retaliatory tariffs, demonstrating restraint as a strategic partner. Instead of escalating tensions, India is focusing on strengthening its domestic economy to outsize external pressures, maintaining calm and pursuing constructive dialogue.

Boosting Domestic Demand: Lower GST rates enhance the affordability of essentials (e.g., roti, hair oil, fast-moving consumer goods) and aspirational goods (e.g., small cars, TVs), encouraging spending. For instance, GST on small petrol/diesel cars (<1200cc/<1500cc) dropped from 28% to 18%, and footwear/apparel below ₹2,500 is now at 5%. This could increase consumer spending by 5-10%, supporting sectors like consumer goods, autos, and retail banking. India’s approach reflects a strategy of making its economic “line bigger” through internal growth rather than attempting to “scuttle” the U.S. through tit-for-tat measures.

Supporting MSMEs: Simplified compliance and lower rates reduce costs for micro, small, and medium enterprises (MSMEs), enabling them to focus on domestic markets. For instance, GST on agricultural machinery (e.g., tractors, sprinklers) dropped to 5%, benefiting rural economies and domestic manufacturing. This aligns with the Atmanirbhar Bharat (Self-Reliant India) initiative. India’s calm response to U.S. tariffs, despite the Trump administration’s efforts to pressure its strategic partner for economic and geopolitical reasons (e.g., Russian oil purchases), underscores its focus on long-term resilience over short-term retaliation.

Economic Resilience: Increased consumption is projected to drive GDP growth to 6.5-7% over the next two years, cushioning the impact of U.S. tariffs. The coordinated fiscal (GST cuts, income tax relief) and monetary (RBI rate cuts) policies create a multiplier effect, with analysts predicting double-digit corporate earnings growth and improved market valuations. India’s strategic patience, avoiding retaliatory measures despite U.S. provocations, positions it to negotiate from a place of strength, potentially by the sidelines of the UN General Assembly in September 2025.

Conclusion

The GST 2.0 reforms mark a pivotal shift in India’s taxation landscape, prioritising affordability, consumption, and economic resilience.

While monthly and annual GST collections may face a shortfall of ₹1.5-2.5 lakh crore, increased consumption, wider tax compliance, and a broader tax base are expected to mitigate losses.

Petroleum products and direct taxes will emerge as major revenue contributors, with the 18% GST slab retaining its dominance.

Defence spending is likely to remain unaffected due to its strategic priority and alternative revenue streams like petroleum excise.

The rupee is expected to stabilise or appreciate slightly, supported by robust growth and FDI inflows.

Monetary policy will likely remain accommodative, with lower inflation enabling sustained or further rate cuts.

Most critically, GST reductions will boost domestic consumption, helping India counter U.S. tariffs by strengthening domestic markets and supporting MSMEs. India’s wise restraint in avoiding retaliatory measures, despite provocative U.S. tariffs, reflects its commitment to strategic partnership and economic self-reliance, ensuring it builds a stronger domestic economy to navigate global trade challenges. As India maintains calm amidst pressures from the Trump-led U.S., it positions itself as a resilient player, delivering tangible benefits to households and businesses while preserving its strategic autonomy.