Restoring fiscal space for the States

For Preliminary Examination:  Current events of national and international Significance

For Mains Examination: GS III - Economy

Context:

The journey of Goods and Services Tax (GST) implementation has entered a major new stage with the latest restructuring of tax slabs, a move expected to pass on over ₹2 lakh crore in tax benefits to consumers. With this, the GST compensation cess stands abolished as it merges with the regular tax, marking the end of an era of compensation under GST

Read about:

Goods and Services Tax (GST)

Finance Commission (FC)

Key takeaways:

• The implementation of the Goods and Services Tax (GST) in India has entered a significant new phase with the recent overhaul of its tax slabs — a reform expected to deliver tax benefits worth over ₹2 lakh crore to consumers.
• This restructuring also marks the discontinuation of the GST compensation cess, which is now integrated into the standard tax system, effectively ending the compensation regime.
• The move is anticipated to stimulate domestic demand and, through higher consumption, offset potential revenue losses.
• However, several States have expressed dissatisfaction, arguing that the Centre has not accurately estimated the magnitude of the loss, which they fear could be substantially greater than projected. Their demand for continued compensation has, therefore, gone unaddressed.
• While earlier studies indicate that GST implementation benefited most States through generous compensation provisions, the post-compensation phase is likely to trigger fiscal concerns. The Centre’s ability to impose cesses and surcharges gives it a degree of fiscal control over States.
• Moreover, since the advent of GST has transferred a substantial portion of taxation authority from States to the GST Council—where the Centre holds a decisive role—there is growing advocacy for revisiting fiscal federalism to reinforce the principle of cooperative federalism.
• India’s fiscal policy, particularly concerning the sharing of revenue between the Union and the States, continues to evolve. Article 246 of the Constitution delineates taxation powers between the Union and the States through the Union and State Lists, with residuary powers vested in the Centre.
• Utilizing these powers, Parliament enacted the 92nd and subsequently the 101st Constitutional Amendments, introducing Service Tax and later, in July 2017, implementing GST.
• For the first time, GST established a destination-based tax structure, enabling both the Centre and the States to share a unified tax base. However, this shift has led to reduced fiscal autonomy for States, as decision-making now lies largely within the GST Council, where the Centre’s influence is dominant.
• Given India’s multi-level system of governance, fiscal asymmetry naturally arises between resource allocation and expenditure responsibilities. Typically, revenue-raising powers are centralized to ensure efficiency, while spending responsibilities are decentralized for better accountability and service delivery.
• To balance these disparities, mechanisms for fiscal transfers and redistribution are employed—requiring continuous adaptation in response to evolving fiscal realities.
• The constitutional framework governing Centre–State financial relations is outlined in Articles 268 to 293. The Finance Commission (FC), constituted under Article 280, is tasked with determining the distribution of resources among States.
• Nonetheless, certain States have voiced concerns that the FC’s criteria for tax devolution tend to disadvantage more progressive States. They also point to inconsistencies in the parameters and weightages adopted across successive Commissions.
• In addition to Finance Commission transfers, States receive funds through Centrally Sponsored Schemes (CSS), Central Sector Schemes, and previously through Planning Commission grants—discontinued after the Commission’s dissolution in 2014.
• While Article 275 provides for statutory grant