The rationalisation of GST rates was an important milestone in the evolution of India’s indirect tax framework. In a recent article, former Chief Economic Advisor Arvind Subramanian and his co-authors have argued that after the discontinuation of the GST compensation cess, states would face revenue losses under the revised arrangement. But the analysis is half-baked as it offers only one side of the story. In a complete analysis, states emerge as net beneficiaries of the GST reform in September 2025 once the overall fiscal impact is decoded.
The authors in the aforesaid article have argued that the compensation cess levied on products such as tobacco, which was earlier transferred entirely to the states, has now been reclassified as an additional excise duty (AED) and subsumed within the basic excise duty (BED). Since BED forms part of the divisible pool and is shared between the Centre and states according to the Finance Commission’s devolution formula, it is argued that states would lose the exclusive benefit they previously enjoyed from the compensation cess.
While this relabelling of compensation cess may indeed result in a perceived revenue loss of around Rs 21,000 crore spread across all 28 states, it is relatively modest and will be more than compensated by two factors: the substantial increase in the overall pie due to the rationalisation; and the increase in taxes from 28% to 40%.
First, our estimates indicate that after accounting for both GST collections and states’ share in BED, states are expected to be net gainers to the tune of roughly Rs 1.43 lakh crore in FY27 as compared to FY26. This is how it will work. In FY26, the total GST collection was Rs 23 lakh crore (including GST compensation cess) while the BED was ~ Rs 45,000 crore. States’ share would thus be SGST + 41% of central and integrated GST (CGST and IGST) and also 41% of BED. Thus, states’ total share in GST and excise duty is ~ Rs 17.7 lakh crore. Under the new arrangement, when GST compensation cess is removed and AED is levied, states’ share in GST (along with 41% of BED) is projected to be ~ Rs 19.1 lakh crore. Thus, states’ total gain is Rs 1.4 lakh crore.
Second, it is important to note that the loss of Rs 21,000 will also be mitigated by the increase in tax on some products from 28% to 40%. Consider an intra-state supply with a taxable value of Rs 100. At the old rate of 28%, states used to get Rs 19.74 and Centre Rs 8.26 (`14 from SGST and Rs 5.74 from the Finance Commission devolution formula at 41%). In the current scenario, the increase from 28% to 40% GST led to Rs 28.2 share for the states and Rs 11.8 for the Centre (Rs 20 SGST + Rs 8.2 from CGST transfer to states). So the new arrangement has effectively led to an Rs 3.54 increase for the Centre and Rs 8.46 for the states.
Therefore, the assertion that states are net losers under the revised GST framework is misleading.
It is important to examine the very objective of the GST compensation cess. The compensation mechanism was never intended to be a permanent source of revenue for states, but rather a transitional arrangement designed to facilitate their shift to the GST regime. Under Section 18 of the Constitution, Parliament was mandated to compensate states for any loss of revenue arising from the implementation of GST.
Accordingly, the GST (Compensation to States) Act, 2017, guaranteed states an annual revenue growth of 14% over the base year (2015-16), with any shortfall between the protected revenue and actual GST revenue being compensated through a dedicated compensation cess levied on demerit and luxury goods such as tobacco, pan masala, coal, and motor vehicles. Thus, the compensation cess was conceived as a time-bound transitional support mechanism, rather than a permanent fiscal entitlement. Furthermore, the GST compensation cess officially expired on February 1, ending its transitional purpose of bridging state revenue shortfalls.
According to GST Council data on taxes subsumed under the GST, earlier there was an average of ~8% growth for states’ revenue from such taxes, while there is ~13% growth in SGST in the post-GST period. Interestingly, the growth in states’ share in GST will be around 7% in FY27 when no compensation cess is given, as compared to FY26. Hence, the very purpose of compensation cess has been fulfilled.
Thirdly, it is false that states will also be facing Rs 14,000 crore loss in FY27 due to the Health Security se National Security Cess. This cess is levied under the Health Security se National Security Cess Act, 2025, on pan masala and any other goods which may be notified by the Centre. The cess will be levied on the machinery installed or other processes undertaken to manufacture or produce the specified goods and for related matters. However, imposing cess is a central government prerogative under Article 270. There is nothing new in this arrangement. Again, such a loss is meaningless given that the overall pie will expand by Rs 1.4 lakh crore.
Cesses existed even pre-Independence and the most important one was the salt cess opposed by Mahatma Gandhi.
Another assumption that needs to be examined is that the GST compensation cess was never a revenue of the Centre because its proceeds ultimately went to the states. The central government levied the cess, which appeared as a Union tax receipt. In the accounting sense, the Centre first collected and recorded it and subsequently transferred it to the GST Compensation Fund within the Public Account of India, which finally went to states as grants.
As expected, after rationalisation the yearly growth of overall GST revenues (including compensation cess) has declined to 5.6% for FY26 from 9.4% in FY25. In Q1 FY27, we expect a rebound in the GST collections and a yearly growth closer to 10%. Clearly, the new GST regime will usher in more revenue for all.