India's GST Reforms Will Weigh on State Finances

(INDRANIL MUKHERJEE/AFP via Getty Images)

A department store on Sept. 5, 2025, in Mumbai, after the Indian government slashed GST rates.

India's consumer tax reforms will help boost disposable incomes and domestic consumption, but revenue shortfalls, pressure on state finances and compliance challenges make them unlikely to counteract the harmful impacts of U.S. tariffs. On Sept. 22, the first major reforms to India's goods and services tax, or GST, since it was introduced in 2017 will take effect, headlined by cutting rates on hundreds of consumer items and simplifying the rate structure from four tiers (5%, 12%, 18% and 28%) to two tiers (5% and 18%). Prime Minister Narendra Modi first made the announcement during his Independence Day address on Aug. 15, when he urged lower taxes and greater self-reliance after the United States imposed 25% tariffs on Aug. 7 (later doubled to 50% effective Aug. 27). On Sept. 3, India's GST Council approved the tax cuts and set Sept. 22 as the effective date for the changes.

Most everyday essentials such as toothpaste and shampoo will see rates fall to 5%. Rates on small cars, air conditioners and televisions will drop to 18%. Insurance premiums for individual life and health policies will become tax-free. Meanwhile, levies on "sin" and luxury goods such as cigarettes, high-end cars and carbonated drinks will increase to 40%.
The GST Council, established in 2016 under the Indian Constitution, is the chief decision-making body for the GST. Chaired by the finance minister and comprising all state finance ministers, it operates on a voting system where the central government holds one-third of the weight and the states two-thirds. Decisions require a 75% majority. Parliament set up the GST system in 2017 and gave the council the power to change rates, meaning such changes do not require parliamentary approval. Once the council decides, the central government and states issue matching notifications under their GST laws, and states are required to implement them.

India's landmark GST unified multiple taxes into a single system to simplify taxation and create a standardized rate across all states, though coverage gaps, compliance difficulties and revenue disputes between the central government and states have been persistent challenges. Introduced in 2017, India's GST is a broad-based indirect tax designed to consolidate a range of central and state levies — including excise duty, service tax and VAT — into a single framework. It was the country's most significant tax change since independence. The system was designed to simplify India's complex tax framework, create a unified national market, reduce opportunities for tax evasion and enhance revenue collection efficiency. For businesses, GST replaced the challenge of navigating overlapping state and central taxes while consumers benefit from more consistent pricing across regions. However, GST's rollout has faced limitations given key sectors, such as consumer alcohol and petroleum products, remain outside its scope and continue to be taxed separately. Additionally, the requirement of online filings, multiple rate categories and the presence of a large informal economy continue to pose compliance difficulties, especially for smaller companies. Disputes between states and the central government over revenue-sharing and the pace of rate rationalization have also slowed progress. Despite, and in some cases because of these shortcomings, policymakers have sought to expand GST's reach and streamline its structure, with the goal of creating a broader, uniform tax regime across the country.

GST revenue is shared between the central and state governments. For sales within a state, the tax is split evenly between the central government and the state where the purchase occurs, but consumers see it as a single combined tax. GST revenue is shared between the central and state governments. For sales between states, the central government collects the tax and passes the share to the consuming state.

While the GST reforms will support growth by boosting disposable incomes and household consumption, they are likely only a short-term measure that threatens to strain some Indian states' budgets. More broadly, U.S. tariffs continue to weigh on the Indian economy. India's GST reforms are deliberately designed to take effect just ahead of the Diwali holiday season in October, a peak period for consumer spending. Government estimates suggest the 42-day festive window could push retail consumption growth to 15%, up from 7% last year. The tax cuts are part of Modi's broader strategy to cushion the economy against U.S. tariffs, which are projected to hit $48.2 billion in exports. By simplifying the tax structure and cutting rates, the reforms are meant to enhance affordability and support demand, building on earlier personal tax cuts that benefited the middle class. While the GST cuts are estimated to cost the central and state government an estimated 480 billion rupees ($5.5 billion) in revenue annually, they will likely boost disposable incomes, stimulate domestic consumption and modestly offset the trade-related reduction in demand, given that private consumption accounts for about 60% of GDP. Although the tax cuts reduce central revenue, the government will likely be able to absorb the impact. However, for state governments, the cuts could strain state finances, trigger disputes over states demanding compensation from the central government and widen the fiscal deficit. Perhaps more significantly, the relief is likely to be short-lived and overshadowed by trade tensions with the United States. The United States is India's largest export market, representing roughly 2% of GDP. India's Chief Economic Adviser V. Anantha Nageswaran has warned that U.S. tariffs could shave 0.5%-0.6% off GDP, putting thousands of jobs at risk in labor-intensive sectors like textiles, gems and jewelry.

In April, the Indian government passed a budget that expanded middle-class spending power by exempting incomes up to 1.28 million rupees (approximately $14,800) from tax while also stepping up investment to spur growth.
Early estimates suggest that states like Bihar, Assam and West Bengal (which earned 61.7%, 50.1%, 46.2% of their tax revenue in the 2025 fiscal year from the GST respectively) and northeastern states such as Mizoram, Arunachal Pradesh and Manipur (over 70% dependence) are most vulnerable, with potential losses of around 0.3% of GDP annually, likely straining capital expenditure. In contrast, southern states like Telangana, Andhra Pradesh and Tamil Nadu and larger states such as Uttar Pradesh and Madhya Pradesh, are less reliant and will likely be more insulated, though some are still pushing back against reduced revenue. The impact on the central government's revenue impact is by contrast more modest, at below 0.15% of GDP.
India is aiming to finalize a trade deal with the United States by November. Progress will likely continue to be slowed by India's protectionist stance on its agriculture and dairy industries, along with continued imports of Russian oil, which Washington has repeatedly criticized. With U.S. tariffs now in place primarily targeting Indian textile and apparel exports, of which the United States makes up about 35% according to India's Apparel Export Promotion Council, producers are grappling with weaker overseas demand and tighter margins. While pharmaceuticals and electronic goods are currently exempt, the risk of new U.S. tariffs on Indian pharmaceuticals is a major concern as such measures would significantly deepen the economic impact. Pharmaceuticals represent about 1.7% of India's GDP. The United States accounted for 31% of India's drug exports in 2023-24.