Are Tariffs the Termites in the Customs House?

With Budget 2026 approaching and the finance minister having made a big announcement for a “customs overhaul”, the clamour for reducing tariffs has acquired fresh life. Economists and op-eds argue for lower tariffs using macro lenses - simple versus weighted averages, competitiveness, the impact of forthcoming free trade agreements, and marginal role in garnering revenue. Manufacturers, meanwhile, seek higher tariff protection for their finished products, even as they ask for exemptions on imported inputs. Yet those same inputs are often produced domestically by someone else, who predictably push back. Each side invokes familiar themes — infant-industry protection, strategic interests, and safeguards against dumping.

In the face of such competing sectoral demands, it is odd how often policy advice defaults to broad-brush templates: keep tariffs higher on finished goods, lower on inputs and components, and push raw materials towards nil. These arguments don’t address the obvious problem — one industry’s “input” is some other factory’s “output” with both sides seeking special and differential treatment.

Mostly, diversity of views enriches public policy. Other times, it can create enough dissonance to pull the system in two directions at once. The government has typically resolved opposing pressures through differential duty rates or by carving out exemptions with complex end-use conditions, often involving undertakings, certifications from other ministries, bonds, bank guarantees, or special schemes. In building these carve-outs, what gets sacrificed is simplicity and ease of doing business; what gets rewarded is discretion and tactics that thrive in the grey zone.

Free trade agreements are a case in point. A report in The Financial Express suggests that as major FTAs become fully operational, more than 80% of India’s trade will move under a duty-free regime. One consequence of FTAs has been the inverted duty structure, which will be further accentuated in coming years. Industry bodies such as CII and FICCI have repeatedly flagged the adverse impact across Industries — aluminium, cement, chemicals, electronics, paper, steel, tyres and textiles. 

Once a concession is locked in through an FTA, fiscal policy cannot neutralise the impact on domestic manufacturers, even if the case appears compelling. When pressures have intensified, the government has reached out for non-tariff measures in the form of Quality Control Orders — a blunt instrument that affects all importers and manufacturers alike. In the wake of recent regulation-driven supply chain disruptions, the government has reportedly withdrawn 200 product categories from QCO coverage.

In the face of a surge in imports neither tariffs nor non-tariff measures can come to the rescue of domestic manufacturers. This is precisely the justification to examine a principled mechanism to neutralise inverted duties for domestic manufacturers, through refunds,  whenever the distortion arises from FTAs or structure of tariffs.    

Keeping the complexities created by FTAs aside, India’s tariff structure remains highly convoluted and the sooner this is acknowledged, the better. There are roughly thirteen or more effective rates of basic customs duty — NIL, 2.5%, 5%, 7.5%, 10%, 15%, 20%, 25%, 30%, 40%, 50%, 75% and 100%. The simplification and consolidation exercise attempted in November this year, produced a 168-page notification with 440 entries and 87 distinct conditions.

Any attempt to “overhaul customs” with the aim of reducing discretion, simplifying compliance and rationalising duties must begin with an assessment of customs revenue in the overall collection of indirect taxes. India collects basic customs duties of ₹2.37 trillion, by no means a trifling sum of money. It is about 3.9% of India’s merchandise import bill of ₹60.5 trillion. Once POL (about 30%) is excluded, the ratio increases to around 5.3%. Customs remains an indispensable point of collection of IGST on imported goods — ₹5.35 trillion — or nearly a quarter of total GST collections in 2024–25. While there can be no denying the enormity of revenue involved, surely tariffs can be built in a more consistent, simpler and comprehensible manner, as shown by the Government in implementing GST 2.0.

World over, certain goods — agricultural commodities, automobiles, alcoholic beverages, tobacco products and bullion — are typically subject to exceptional tariff treatment and can be excluded from any broad-brush redesign. For the rest, there is a strong case for a standardised customs duty structure. BCD could be a flat 5% across the board, without reference to classification, exemption notifications, or scheme-based carve-outs. That would eliminate discretion, rationalise rates, while sharply shrinking the grey zone and space for disputes.