Restoring fiscal space for the States:

The Hindu: Published on 17th Oct 2025. 

 

Why in News?

The issue of fiscal autonomy for Indian States has resurfaced after the abolition of the GST compensation cess and the recent restructuring of GST tax slabs.

Although the move is expected to pass on ₹2 lakh crore in tax benefits to consumers, several States have expressed concern over uncompensated revenue losses and increasing centralisation of fiscal powers.

Their expenditure responsibilities are rising due to growing public expectations, while their tax collection powers are shrinking.

 

Background:

The Goods and Services Tax (GST) was introduced in 2017 (101st Constitutional Amendment), replacing multiple indirect taxes with a unified structure.

Initially, States were compensated for five years for any revenue loss through the GST Compensation Cess.

With the end of this compensation period and cess abolition, many States now fear a reduction in fiscal space.

Rising cesses and surcharges, which are not shareable with States, have further weakened their revenue base.

 

Key Issues:

(a) Erosion of Fiscal Autonomy:

GST shifted major taxation powers to the GST Council, where the Centre holds more influence.

 

(b) Rising Cesses and Surcharges:

These now account for ₹4.23 lakh crore (BE 2025–26) and are excluded from the shareable tax pool, limiting State revenues.

 

(c) Falling Share of Devolution:

Despite recommendations of 41–42% tax devolution, the actual share remains lower due to exclusions.

 

(d) Mismatch in Revenue and Expenditure:

States handle sectors like health, education, and agriculture, but lack adequate resources.

 

(e) Centre’s Control via Centrally Sponsored Schemes (CSS):

Central control over many schemes in State subjects reduces State-level fiscal freedom.

 

Constitutional & Institutional Dimensions:

Articles 268–293: Define Centre–State financial relations.

Article 280: Establishes the Finance Commission for recommending tax sharing.

Article 275: Provides for statutory grants to States.

Article 282: Allows the Centre to make direct grants.

80th Amendment (2000): Replaced tax-wise sharing with global sharing.

101st Amendment (2016): Introduced GST, altering the power balance between Centre and States.

 

Data Insights:

Central transfers account for 44% of State revenues on average.

Bihar: 72% dependence

Haryana: 20% dependence

Cesses and surcharges: ₹3.86 lakh crore (2024–25 RE) → ₹4.23 lakh crore (2025–26 BE).

Pre-GST: Centre 67%, States 33%.

Post-GST: Ratio unchanged, but States’ expenditure has risen due to welfare responsibilities.

 

Impact:

Positive:

Simplified GST structure could boost local demand and improve compliance.

Consumer prices may reduce due to lower tax burden.

 

Negative:

States’ fiscal dependence on the Centre increases.

Loss of autonomy in designing welfare schemes.

Liquidity issues and political friction may rise, especially for opposition-ruled States.

 

Demands & Suggestions:

Merge cesses and surcharges with shareable revenue.

Share the personal income tax base between Centre and States (50:50 model).

Allow States to “top-up” income tax without disturbing current structure.

Adopt the Canada model: Provinces collect 54% and spend 60%, ensuring local flexibility.

Strengthen Finance Commission’s transparency and consistency.

Reform the GST Council to enhance States’ say in decision-making.

 

Future Outlook:

India must revisit fiscal federalism to ensure that States have sufficient resources for public welfare.

A more balanced tax-sharing framework would promote cooperative federalism, reduce friction, and improve fiscal efficiency.

The upcoming 16th Finance Commission may play a crucial role in redefining this balance.

 

Conclusion:

• GST simplified India’s taxation system but centralised fiscal control.
• With expanding responsibilities, States need greater fiscal space and autonomy.
• Reforming tax devolution, integrating cesses, and granting flexible taxation rights are vital for a truly federal financial system.