Answer

The GST Compensation Cess, introduced in 2017, was designed to compensate states for revenue losses following GST implementation, based on an expected 14% annual growth from 2015–16. Originally planned for five years, its term has been extended to March 2026, raising questions about fiscal prudence and the dynamics of Centre-State financial relations. This extension has sparked renewed discussions on whether to phase out or repurpose the cess.

Implications of Continued Reliance on GST Compensation Cess

• Undermines GST Uniformity: The ongoing cess distorts the ‘one nation, one tax’ principle by creating non-uniform tax rates across States.
  Eg: Luxury items like cars and tobacco attract both GST and cess, complicating the tax structure.
• Increases Consumer Prices: The cess adds to the cost of goods such as tobacco and luxury items, fueling inflation.
  Eg: The automotive sector faces increased prices due to the combined GST and cess burden..
• Centre’s Fiscal Overdependence: Continued reliance reflects the Centre’s burden to manage historic compensation liabilities.
  Eg: The Centre is set to repay ₹2.69 lakh crore GST compensation loans from FY21 and FY22 by November 2025, using cess collections.
• Delays in State Reforms: Dependence on compensation delays States from broadening their tax bases and improving their own revenue.
  Eg: Some States hesitated to expand GST coverage due to guaranteed cess compensation.
• Distorts Consumption Behaviour: A Higher cess on specific goods affects consumer demand patterns.
  Eg: Tobacco, colas, and luxury goods remain costly, impacting small sellers and middle-income consumers.

Arguments Against Phasing Out the GST Compensation Cess

• States Still Need Support: Several States continue to face revenue shortfalls and depend on compensation.
  Eg: States such as Punjab rely substantially on this compensation, making it a crucial component of their overall revenue.
• COVID-19 Impact Not Fully Over: The cess extension was crucial for compensating for pandemic-related fiscal shocks.
• Risk of Fiscal Gap: Abrupt cess removal might create budget deficits for States reliant on the compensation.
  Eg:  In 2023–24, Karnataka estimated a ₹26,954 crore shortfall in GST collections due to the cessation of the compensation scheme, highlighting the state’s ongoing fiscal challenges.
• Political Opposition: States fearing revenue loss may resist GST reforms if the cess is removed prematurely.
  Eg: States like West Bengal and Kerala have opposed the cess phase-out, citing financial risks.
• Incomplete Compensation Mechanism: A permanent revenue-sharing framework post-cess is still under development.
  Eg: The GST Council is yet to finalize a formula replacing cess-based compensation after 2026.

Arguments in Favour of Phasing Out the GST Compensation Cess

• Purpose Achieved: The GST system has matured, and States’ revenues have stabilized, making the cess phase-out timely.
  Eg: GST collections hit ₹1.85 lakh crore in June 2025, reflecting economic recovery.
• Stimulates Demand: Removing cess lowers prices, encouraging consumer spending and economic revival.
• Simplifies Taxation: Aligns with GST Council’s plan to reduce multiple tax slabs and simplify the structure.
  Eg: Fitment committee recommendations advocate cess elimination to streamline tax rates.
• Promotes State Accountability: Encourages States to enhance their own revenue sources and reduce reliance on compensation.
  Eg: States like Gujarat and Karnataka successfully diversified revenues post-cess reduction.

India must rethink the GST compensation cess post-2026, possibly transforming it into a green cess to support environmental goals. Strengthening state revenues, reducing dependence on cesses, and implementing GST reforms will ensure fiscal sustainability, balanced Centre-State relations, and inclusive growth aligned with India’s economic and climate priorities.

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