Q. Discuss the implications of continued reliance on GST compensation cess beyond its original purpose. Should the cess be phased out? Substantiate your view. (15 Marks, 250 Words)

Core Demand of the Question

  • Implications of continued reliance on GST compensation cess beyond its original purpose.
  • Arguments against phasing out the GST compensation cess.
  • Arguments in favour of phasing out the GST compensation cess.

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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Quick Revise Now !
UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
Integration of PYQ within the booklet
Designed as per recent trends of Prelims questions
हिंदी में भी उपलब्ध

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