Eight states call for compensation mechanism to safeguard states’ revenue after GST rate rationalisation

A group of eight states has flagged potential revenue losses under the goods and services tax (GST) and have sought further compensation while supporting the move to rationalise rates under the indirect tax levy. They have also called for a mechanism to ensure that the GST rate cuts are passed on to end consumers and are not made part of corporate profits.

The issues were flagged at a meeting of states including Himachal Pradesh, Punjab, Karnataka, Jharkhand, Kerala, Punjab, Tamil Nadu, Telangana and West Bengal on Friday where they held a consultation on GST rate rationalisation and the impact on state finances.

“We are unambiguously clear that we are for rate rationalisation. At the same time, we have discussed two other issues – the revenue interest of states should be protected. Benefits of rate rationalisation should reach the common people and not become a part of the windfall profits for some companies,” said Krishna Byre Gowda, Revenue Minister of Karnataka.

The states have suggested that revenue loss must be fully compensated through a mechanism similar to the GST Compensation cess. They have also proposed that an additional levy on sin and luxury goods should be imposed to maintain the current effective level of taxation. These proceeds must be fully transferred to states. They pointed out that the Centre’s proposal of a mechanism to retain the effective tax incidence on sin and luxury goods is not clear. For instance, pan masala bears an effective incidence of nearly 88% and a reduction to 40% would create a shortfall of 48%. Significantly the cess on luxury and sin goods contribute about 7-8% of GST collections.

They have further proposed that the Union should raise loan to compensate the balance revenue loss of states and repay it by extending the compensation cess beyond five years. The base year for compensation should be FY2024-25, they have put forward, adding that the protection should be granted at the rate of 14% per annum which is also the average of the growth rates of the preceding three financial years.

Compensation should be assured for a minimum period of five years, beyond which it may be reviewed based on GST buoyancy.

Underlining that even BJP ruled states are concerned about revenue losses, these states have decided to jointly request the GST Council to place their proposal in the agenda for the upcoming meeting on September 3 and 4.

The eight states are set to meet again on September 3 to discuss their proposals in further detail before the Council meeting. It is to be seen how the issue is taken up in the Council and whether states will agree to the rate rationalisation without safeguard to prevent revenue loss. Jharkhand finance minister Radha Krishna Kishore underlined that the issue will be taken up strongly in the GST Council.  

At the heart of the matter is the Centre’s proposal for a dual rate GST of 5% and 18% along with a higher rate of 40% for specified sin goods and luxury items while scrapping the 12% and 28% rate and letting the compensation cess come to an end. States are concerned about revenue losses from these proposals contending that even now their revenue is not back to the pre-GST level.

While there are no exact calculations on the potential revenue loss from the move, the Karnataka finance minister said it may be in the range of Rs 1.5 lakh crore to Rs 2 lakh crore annually based on estimates of private institutions and experts.

He pointed out that between FY18 and FY24, the net effective GST rate fell to 11.6% due to rationalisation of rates from the earlier 14.4%. With the current proposal, the net effective GST rate could go down further to below 10%.

States anticipate about a 15% to 20% loss from their current GST revenue due to rationalisation of rates and the additional revenue foregone due to not merging the compensation cess fully into the GST rate structure. “Such a revenue shock cannot be fully absorbed by the states without drastically reducing developmental expenditure,” they warned.

Kerala Finance Minister KN Balagopal said that the state only got about Rs 32,000 crore from GST in FY25 compared to pre-GST sales tax revenue of Rs 51,000 crore. Telangana finance minister Mallu Bhatti Vikramarka said it will lose about Rs 7,000 crore on account of the GST proposals and said this would be the case for every states. “It will be difficult to go ahead with planned infrastructure and development activity,” he said.

Punjab FM Harpal Singh Cheema also pointed out that in the eight years of GST, the Council has given exemptions 27 times and reduced rates 15 times and revenue losses continue. Punjab has lost Rs 1.11 lakh crore in the last eight years due to GST of which it received Rs 60,000 crore from the compensation cess.