Downward GST revisions spark further revenue-cut fears in states

While the Centre’s promise to lower the GST rates and simplify its complex design is a welcome move for consumers and businesses, state governments are worried that this would mean an annual loss of Rs 7,000–9,000 crore in revenue for them and slow down their revenue growth.

Having surrendered their rights to indirect taxes on most items — except petroleum and petroleum products and alcohol for human consumption — at the time of adopting a centralized GST system in 2017, states don’t have much of a choice now.

But they have sound reasons to feel aggrieved. Over the past few years, the Centre has choked their fiscal space through various means — by not honouring the Finance Commission (FC) awards on devolving tax revenue, by raising cess and surcharge which are not part of the divisible pool and aren’t shared with states, and by spending more funds on central sector and centrally sponsored schemes.

Also read: FM Sitharaman unveils sweeping GST reform plan to GoMs

Here is how the Centre has choked states’ revenue sources.

1. Centre devolving less revenue than Finance Commission awards

The Centre shares its tax revenue with states as per the FC’s rewards. The 15th FC fixed the states’ share at 41 per cent of the Centre’s gross tax revenue for five fiscals of FY21-FY25. This was one per cent lower than the 14th FC’s award for FY16-FY20. The 13th FC had awarded 32 per cent for the period of FY11-FY15.

But the Centre has been consistently short-changing states in honouring these awards.

Budget documents show the gap between the FC awards and actual devolution remains very high. During FY21-FY25, states received an average of 31.8 per cent of the Centre’s gross tax, which was 9.2 per cent lower than the award. The gap was even higher (-7.1 per cent) during the previous fiscals of FY16-FY20 though. The gap was much lower, at -4 per cent during FY12-FY15, when the FC award was 32 per cent, with the average devolution of 28 per cent.

Also read: Spotlight on prospective GST rate cuts pushes current sales into the dark

2. Total transfers to states falling too

The Centre devolves funds to states in more ways than one. Apart from the FC awards, it gives grants-in-aid to cover revenue deficit of states, local body grants, grants for states’ disaster relief fund (also determined by the FC) and funds central sector schemes and centrally sponsored schemes.

This is inevitable because in India’s quasi-federal structure, the Centre has disproportionate power to raise taxes but no state of its own to spend on. States lost the remaining power to raise indirect taxes by adopting the centralized GST in 2017.

Budget documents show that total transfers to states averaged 36 per cent of the Centre’s gross revenue — comprising gross tax and non-tax revenue and capital receipts — during FY15-FY25.

Given the accounting changes in the Budget documents, it is difficult to compare the current situation with the past, but the 14th FC report of December 2014 clearly stated that the “aggregate transfers accounted for around 50% of gross revenue receipts of the Union.”

Two reasons for the lower devolution of revenue are the Centre’s push for more (i) cess and surcharge and (ii) central sector schemes (CS) and centrally sponsored schemes (CSS). Cess and surcharge are not part of the divisible pool and hence not shared with states. Ascent on CS and CSS mean less fund available to share with states.

Also read: Four ways in which recent restructuring has altered tax dynamics

3. High on cess and surcharge

A Rajya Sabha reply of July 29, 2025 shows, cess and surcharge collected by the Centre has come down but still remain very high — averaging 16.1 per cent of the Centre’s gross tax. It is no secret that the Centre expanded cess and surcharge in reaction to the 14th FC award — which raised states’ share from 32 per cent to 42 per cent.

The Centre had strongly opposed this hike in its presentation to the 14th FC in September 2014 — which was duly recorded in the commission’s report — but the commission brushed it aside. The Centre, however, got the 15th FC to lower the award to 41 per cent by arguing that it needed more funds because Jammu and Kashmir had been placed under its rule. The Centre revoked the special status of Jammu and Kashmir and downgraded it to two Union territories in 2019.

Also read: Proposed GST reforms aren’t next-gen but design flaws introduced in 2017

4. Central schemes on the rise

During the previous UPA government, both CS and CSS were curtailed to pass the funds to states to prioritize their own development goals. But it was reversed in 2014 with more and more central schemes being announced, peaking during the pandemic lockdown — contrary to the Centre’s public denouncement of centralized planning and one-size-fits-all solutions. In fact, that was the reason it had dismantled the Planning Commission in 2014.

CS are fully funded by the Centre, while CSS are shared by the Centre and states according to pre-determined funding shares. In FY25, there were 676 CS and 75 CSS (total of 751 schemes). In FY26, CS has come down to 636 but SCC have gone up to 81 (total 718).

True, the Centre is giving 50-year interest-free loan to states since FY23, under “Scheme Special Assistance to States for Capital Investment”. It disbursed Rs 81,195 crore in FY23, Rs 1,09,554 crore in FY24, Rs 1,25,000 crore in FY25 (RE) and budgets Rs 1,50,000 crore for FY26 (BE). This scheme was launched after the Centre discontinued paying GST Compensation to states in FY22 — as it was meant to be under the GST law of 2017.

But these loans are largely tied to specific reforms — that is, states are not free to spend as they wish. And then, the Centre has also put a tight leash on states by restricting their borrowings to 3 per cent of their respective GSDP — even when states have historically proved far more fiscally responsible and prudent than the Centre.