Why is it in the News?
- The GST compensation cess has been merged with the regular GST, ending the compensation mechanism for States.
- This move is expected to pass on over₹2 lakh crore in tax benefits to consumers and potentially boost local demand.
- Certain States fear revenue losses and erosion of fiscal autonomy, arguing that no proper estimation of losses has been made.
- The decision reignites discussions on Centre-State fiscal relations, cooperative federalism, and the sharing of tax powers.
Relevance
- GS-3: Indian Economy – Taxation, Centre-State relations, Fiscal Federalism, Public Finance, Revenue Sharing.
GST and Fiscal Policy
GST Introduction:
- Launched in July 2017 through the 101st Constitutional Amendment.
- Replaced multiple indirect taxes with a common destination-based tax, shared between Centre and States.
- Initial GST compensation mechanism ensured States were not worse off due to revenue loss.
Centre-State Fiscal Relations:
- Articles 246–293 govern taxation powers and transfers.
- Finance Commission (Article 280) recommends devolution of funds to States.
- Central transfers still account for 44% of States’ revenue receipts, with Bihar at 72% dependence, Haryana at 20%.
- Dependence on Central transfers affects liquidity, fiscal autonomy, and political leverage.
Revenue Sharing History:
- Pre-GST (2012-17): Centre collected 67%, States 33%. Post-GST (2018-23): ratio remained similar.
- Devolution share recommended by Finance Commissions increased from 29.5% (11th FC) → 42% (14th FC), but actual devolution fell short due to cesses and surcharges, which remain non-shareable.

Overview
Impact of GST Compensation Cess Merger
- Consumers may benefit from lower prices, boosting demand.
- States risk revenue loss: compensation previously guaranteed annual shortfalls.
- Cess and surcharge previously gave the Centre additional leverage, now merged, reducing that buffer.
Erosion of Fiscal Autonomy
- GST centralises tax power in the GST Council, dominated by the Centre.
- States’ ability to independently raise revenue is limited.
- Progressive States (e.g., Tamil Nadu, Maharashtra) contribute more to taxes but cannot fully retain the benefits.
Structural Issues in State Finances
- Expenditure responsibilities are higher at State level: health, education, agriculture, local governance.
- Central transfers and grants (CSS, CFS, Finance Commission) supplement but are performance-based or conditional.
- Heavy dependence on the Centre creates fiscal vulnerability and political friction, especially in opposition-ruled States.
Proposed Solutions for Greater Fiscal Autonomy
- Sharing personal income tax base with States on a 50:50 basis, similar to GST.
- Allowing States to top up income tax rates without altering the current levy system.
- Such reforms would:
- Reduce dependency on Centre.
- Improve liquidity and planning.
- Reward progressive States contributing higher revenue.
Comparative Perspective
- Example of Canada: Federal govt collects 46%, sub-national governments 54%; federal spends 40%, provinces spend 60%.
- Suggests a model where States have more autonomy in raising resources and spending, improving accountability and service delivery.
Takeaway
- GST restructuring is a double-edged sword: consumer benefit vs. potential revenue loss for States.
- Centralised tax authority ensures uniformity but reduces State fiscal autonomy.
- A dynamic approach to tax sharing and grants is critical to maintain cooperative federalism.
- Fiscal reform may require structural redesign of transfers, tax bases, and conditionalities to empower States.