Let’s take Trump’s tariff tirade as an opportunity for tax reforms

They function less as blanket barriers and more as a response to distortions: an overvalued rupee that makes exports uncompetitive, goods and services tax (GST) exemptions that give imports an unfair edge and transfer-pricing practices that allow multinationals to shift profits abroad.

Since tariffs are shaped by wider trade and fiscal policy, they serve to disguise rather than cure the structural weaknesses that limit India’s competitiveness.

They have been employed to protect domestic industry, encourage local manufacturing and cut import dependence. But continued reliance on tariffs risks trapping India in a cycle of inefficiency and retaliation, emphasizing the urgency of structural reforms.

An overvalued rupee is a major problem as it makes imports cheaper and exports more expensive, effectively acting as a tax on exporters and a subsidy for importers. This undermines export-oriented domestic production by reducing India’s competitive advantage in global markets.

Instead of using high tariffs to counteract this, India should allow the rupee to depreciate sharply to its true market value. This would make Indian exports much more competitive and neutralize high US tariffs.

As exports rise, the rupee will appreciate, creating a natural reset in its value without intervention by the Reserve Bank of India. The adjustment may create short-term price pressures as imports get costlier, but these would be outweighed by the long-term benefits of stronger export growth and a better balanced trade account.

Another factor influencing India’s trade prospects is the exemption of certain goods, including their imports, from GST. Eliminating these exemptions, with a single rate of 12% used across all goods and services, would create a level playing field, restoring fairness for domestic manufacturers and encouraging investment in local production.

At the same time, concerns that ending exemptions might raise costs for the vulnerable can be effectively addressed through direct cash subsidies.

India already has excellent digital infrastructure in place, undergirded by Aadhaar, Jan Dhan accounts and the Unified Payments Interface, that enables the government to make direct cash transfers to those in need of support.

By using this system to protect low-income households from any cost rise, India can make the GST regime more equitable and efficient, supporting domestic industry without compromising social protection.

Tariffs also serve as a blunt tool to counter profit-shifting by multinational corporations. Many of them manipulate intra-group trade prices to minimize their taxable income, undervaluing Indian exports or inflating imports to shift profits to low-tax jurisdictions.

A destination-based cash flow tax (DBCFT) offers a clean and more effective solution. As opposed to corporate income tax, which is tied to where profits are reported, a DBCFT would be applied on the value of sales in India.

Its border adjustment—taxing imports while exempting exports—would neutralize the incentive to shift profits abroad and safeguard the domestic tax base without relying on tariffs.

By eliminating the source of transfer-pricing abuse, a DBCFT (with some tweaks) would provide India with a system for taxing global companies that is more transparent and also WTO-compliant. This would improve revenue stability and investor confidence.

While tariffs have helped offset such distortions, they carry heavy costs. Trading partners often retaliate, curbing India’s export access, even as consumers pay more and industries reliant on imported inputs see their competitiveness eroded.

High barriers also deter foreign direct investment, as global firms view India as a costly and less predictable market. A DBCFT paired with a truly free-floating rupee can deliver the same protection with far fewer side effects.

A rupee allowed to find its natural value would make exports more competitive in the short term; as foreign demand strengthens, export earnings would eventually support a more stable and sustainable currency level.

Also, such reforms would enhance our credibility in trade talks, showing that we are committed not to protectionism but to fair, modern and efficient frameworks that encourage open trade.

We need a decisive shift away from tariffs as India’s main line of defence to a more efficient system that corrects distortions without undermining growth.

By adopting a DBCFT, ending GST exemptions and letting the rupee adjust to market forces, India would strengthen its export competitiveness, create a fair playing field for domestic producers and remove distortions caused by currency misalignment and tax loopholes.

Such reforms would let us reduce our average tariff rate to a uniform band of 3-5% (without exemptions), with lower rates applied where free trade agreements call for it.

This would not only dispel perceptions of India being a high-tariff economy, but also align our trade regime with global norms.

We must resist the temptation to counter Trump’s tariff rhetoric with a competitive tariff structure, as this would undermine the interests of the Indian economy.

Instead, by implementing the above reform measures as a comprehensive package, the country would be far better placed to seize opportunities that arise once the ongoing storm of tariff rhetoric subsides.

The author is former member, Central Board of Direct Taxes, and former senior economist, International Monetary Fund.