Explainer: How GST relief has states on edge

WITH the Goods and Services Tax (GST) regime set for a sweeping overhaul effective September 22, negotiating the fiscal impact of the customer-centric ‘GST 2.0’ reforms poses a challenge for the states. Several voices have expressed concerns about the short-term revenue losses that could strain welfare budgets. Post the elimination of GST slabs of 12 and 28 per cent, customers will have a streamlined structure of just two primary rates — 5 and 18 per cent. The changes, approved unanimously by the GST Council in its 56th meeting on September 3, are aimed at easing the tax burden on everyday essentials.

What is the revenue share

The GST, introduced in 2017 as a unified indirect tax replacing a plethora of levies like VAT and excise duty, has been termed a cornerstone of India’s economic integration. Under the dual GST framework, intra-state transactions are split equally between the Centre (via Central GST or CGST) and states (via State GST or SGST), ensuring a 50-50 revenue share.

For inter-state supplies, the Integrated GST (IGST) is collected by the Centre and apportioned based on the destination principle — meaning revenue accrues to the consuming state rather than the producing one. This destination-based model promotes equity by aligning collections with consumption patterns, benefiting populous consumer states like Uttar Pradesh over industrial hubs like Maharashtra.

States’ GST benefits stem directly from this sharing mechanism. In fiscal year 2024-25, gross GST collections hit a record Rs 22.08 lakh crore, with states receiving roughly half after IGST settlements.

Compensation cess revenues, levied on luxury and sin items, were historically used to offset states’ initial revenue shortfalls from GST’s rollout, guaranteeing a 14 per cent annual growth over pre-GST levels until 2022.

In the post-compensation era, states like Bihar and Gujarat remain heavily reliant, with GST comprising over 40 per cent of own tax revenues for 12 of India’s top 15 states by GSDP.

Impact of rationalisation

The rationalisation, announced by Finance Minister Nirmala Sitharaman after a marathon GST Council meeting, merges most items from the 12 per cent slab into 5 per cent and 90 per cent of 28 per cent slab goods into 18 per cent. Essentials, small appliances, bicycles, and pressure cookers now fall under 5 per cent or 0 per cent, slashing costs for households.

Life and health insurance premiums are exempt (0 per cent), while automobiles (small cars, buses, trucks) and electronics (ACs, TVs, washing machines) shift to 18 per cent. Inverted duty structures in textiles and fertilisers have been corrected, with man-made fibers dropping to 5 per cent.

At the high end, the new 40 per cent slab targets “demerit” items like tobacco, cigarettes, paan masala, online gaming, and casinos — replacing the previous 28 per cent plus cess (effective up to 50 per cent). This is expected to generate additional revenue from discretionary spending, though casino operators in Goa have raised alarms over job losses and reduced footfall.

What states are asking for

While consumers and industries hail the “Diwali gift” for boosting disposable incomes and compliance — potentially lowering inflation by 75 basis points and spurring Rs 2 lakh crore in festive spending — the fiscal math has states on edge. The Centre estimates a net revenue implication of Rs 48,000 crore annually, based on 2023-24 data, with the 18 per cent slab (67-74 per cent of revenue) largely intact.

Optimists, including SBI Research, peg the hit at just Rs 3,700 crore, arguing higher consumption volumes will offset losses through a wider tax base and reduced evasion. Yet, Opposition-ruled states like Kerala, Tamil Nadu, Punjab, Karnataka, HP and West Bengal warn of steeper short-term losses in GST revenue — Rs 70,000- Rs 1.8 lakh crore — disproportionately affecting them as consumption patterns favour higher-taxed essentials.

Kerala Finance Minister KN Balagopal highlighted that states’ GST dependency (up to 50 per cent of own taxes) could cripple welfare schemes. Eight states have demanded a new mechanism somewhat similar to compensation cess, including full allocation of 40 per cent slab cess proceeds for 4-6 years and relaxed borrowing limits (up to 4 per cent of GSDP).

Who will gain

Producing states like Maharashtra and Gujarat may gain marginally from boosted inter-state trade and manufacturing, but consumer states with high essential spending (like Bihar and UP) fear amplified losses. Jefferies estimates states bearing two-thirds of the Rs 22,000-Rs 24,000 crore FY26 impact, though buoyant demand could neutralise it by FY27 as cess converts to regular GST.

To offset the revenue losses, the states would have the option to increase excise duty or increase taxes on petroleum products and can also consider imposing cess such as green etc. The Centre, emphasising revenue neutrality, has ruled out direct compensation but promised data-driven monitoring.