The Southern Discomfort: Bearing the burden of GST rationalisation

The southern states, barring NDA-ruled Andhra Pradesh, are doing a delicate balancing act on the overhaul of the Goods and Services Tax (GST) regime: Welcoming the intent behind the rationalisation of GST slabs on one hand, while on the other, seeking adequate compensation to the states for the revenue losses. This is a perfect pitch to preserve the country’s federal spirit.

No reform can yield the desired results if the concerns of the states are not properly addressed, in accordance with the principles of federalism. There is a strong case for compensation here, because the GST rate cuts would disproportionately affect the finances of the states, which are more dependent on GST revenues compared to the central government.

Estimates of the revenues anticipated to be foregone due to the proposed tax cuts range from around Rs 50,000 crore during the current financial year, to nearly Rs 1.4 lakh crore in the next financial year. Since 70 per cent of the burden would fall on the states, the demand for compensation is perfectly legitimate.

The success of the GST reforms would, therefore, depend on how well the states are compensated for the losses they are bound to incur. The onus is on the Centre to evolve a proper mechanism to safeguard the states from the adverse impact of the GST reform.

The 56th meeting of the GST Council has approved the revised two-tier tax structure — consisting of 5 per cent and 18 per cent rates — while an additional 40 per cent slab has been created for certain ‘sin’ and luxury goods. The previous slabs of 12 per cent and 28 per cent have been eliminated.

Unified strategy

In a show of solidarity, eight non-NDA states — Telangana, Karnataka, Tamil Nadu, Kerala, West Bengal, Himachal Pradesh, Punjab and Jharkhand — have come up with a joint strategy to push for revenue protection from the Centre. They have also suggested levying an additional duty on sin and luxury goods, over and above the proposed 40 per cent rate, which should be proportionately distributed among the states.

“The rate rationalisation should be supported by a robust revenue protection framework, a supplementary levy on sin and luxury goods, and a guaranteed compensation mechanism for at least five years. Only such a balanced approach will protect the fiscal autonomy of the states while advancing the objectives of GST reform in the true spirit of cooperative federalism," said a joint statement issued after a meeting of the finance ministers of these Opposition-ruled states ahead of the GST Council meet.

The idea behind this shared approach is to ensure that the states should get their compensation and the consumers should get full benefits of the GST rate cuts. The effort is to see that the corporates should not be allowed to convert the GST cuts into windfall profits.

Another long-term concern of the southern states is that the post-GST tax devolution formula, based heavily on population, could end up penalising states with effective population control policies.

States take the hit

Rationalisation of the GST seeks to further simplify the rate structure by reducing the number of slabs and shifting many items to lower tax slabs. Such rationalisations have been premised on the expectation of significant medium- to long-term revenue gains, driven by efficiency improvements and higher consumption.

However, each round of rationalisation has hurt state revenues as the buoyancy expected to compensate for these revenue losses has not materialised. It is estimated that between FY18 and FY24, the net effective GST rate fell from 14.4 per cent to 11.6 per cent due to the rationalisation of rates.

Hence, the Southern states, along with other Opposition-ruled states, demanded that any new proposal for rate rationalisation must be tempered by a realistic assessment of the extent to which buoyancy can compensate for revenue losses.

They argued that it should be accompanied by clear safeguards built into the GST framework to protect the fiscal interests of the states, given the very high likelihood of a substantial revenue shortfall post-rate rationalisation.

Telangana to lose Rs 7,000 crore

Telangana, India’s youngest state, is estimated to lose nearly Rs 7,000 crore annually following the proposed GST rate rationalisation. Deputy chief minister Bhatti Vikramarka, who holds the finance portfolio, said the state’s cumulative losses since the introduction of GST have already crossed Rs 80,000 crore.

“Had the GST not been implemented, the state would have earned Rs 69,373 crore in 2024-25. But actual revenues stood at Rs 42,443 crore, resulting in a loss of Rs 27,000 crore this year alone,” he said.

Pointing out that the Centre had promised 14 per cent annual growth in states’ tax revenues at the time of GST rollout, the finance minister said the commitment had not been honoured as growth remains restricted to 7-8 per cent.

“Rate rationalisation is welcome, but if a state stands to lose Rs 7,000 to Rs 10,000 crore every year, its welfare and development programmes will suffer. We request the Centre to use the cess and tax collected on luxury and sin goods to compensate states,” Vikramarka said.

“Over 80 per cent of our revenues are tied to welfare schemes. GST accounts for just 39 per cent of our own tax revenue. So, any reduction directly hurts us. Telangana is estimated to lose at least Rs 5,100 crore from rate rationalisation alone, with the overall impact nearing Rs 7,000 crore, or about 15 per cent of GST revenue. Such a fall will weaken our financial stability,” he explained.

The minister pointed out that Telangana’s GST-to-GSDP ratio had already declined from 3.07 per cent in 2022-23 to 2.58 per cent in 2024-25, and rationalisation would push it lower.

“States are losing fiscal freedom but not being given new mechanisms to raise resources. Cooperative federalism requires that the Centre hold consultations before imposing such sweeping changes,” he said.

Danger of fiscal destabilisation

Karnataka’s finance minister Krishna Byre Gowda said each state would lose 15-20 per cent of its GST revenue under the new regime, which would destabilise the fiscal structure of the states.

He pointed out the decrease in net rate of taxation to 11 per cent from the 14.4 per cent revenue — or neutral rate — when the GST update was implemented.

The Centre’s proposal to further reduce GST rates and cut down the number of slabs would further decrease the net rate of taxation to 10 per cent, Gowda said.

Kerala’s finance minister K.N. Balagopal said the common concern among the southern and other non-NDA ruled states is that the substantial revenue loss could lead to disruption in social welfare programmes and developmental expenditures.

He said the tax reduction should be passed over to the common people and should not result in profiteering. “We have reached a consensus regarding the minimum safeguards for the states’ revenue interests even while achieving GST rate rationalisation,” he said.

Tamil Nadu finance minister Thangam Thennarasu, who recently hosted the meeting of the finance ministers where a common strategy was chalked out, said the like-minded states would continue to press for compensation to mitigate the impact of the GST cuts. With the latest rate rationalisation proposals, it is expected that the net effective GST rate would fall below 10 per cent. It is therefore not correct to assume that future rationalisation will automatically deliver the buoyancy required to offset revenue loss," he contended.

"While welcoming the intent of reform, we stressed that any reduction must not erode state revenues that sustain welfare programmes and infrastructure. We urged that the benefits of lower rates must directly reach common people," Tamil Nadu chief minister MK Stalin said in a post on X.

Andhra, the outlier

The NDA-ruled Andhra Pradesh has turned out to be an outlier among the southern states on the issue. Chief minister N. Chandrababu Naidu, a key ally of the BJP (for one thing), has extended unequivocal support for the Centre’s proposals, saying they will help the common man and expand the Indian economy.

“GST rate cuts on steel and cement will ease the burden on the government and people. The move will help revive the Indian economy. Prices will fall as GST is cut from 28 per cent to 18 per cent and 5 per cent on key items. These reforms will bring positive change in people’s lives.

“The state government assures full support to the Centre’s GST initiative," state finance minister Payyavula Keshav said.