Goods and Services Tax (GST)

Weakening financial capacity of States


From UPSC perspective, the following things are important :

Prelims level: GST provisions

Mains level: Paper 2- Declining financial heath of the States

The financial health of the States has been declining in the last several years. The article explains the reasons and its implications for the States.

Role of States in development

  • State governments drive a majority of the country’s development programmes.
  • Greater numbers of people depend on these programmes for their livelihood, development, welfare and security.
  • States need resources to deliver these responsibilities and aspirations.

Factors responsible for declining discal capacity of the States

1) Declining devolution to State

  • Finance Commissions recommend the share of States in the taxes raised by the Union government and recommendations are normally adhered to.
  • The year 2014-15 commenced with a shock: actual devolution was 14% less than the Finance Commission’s projection.
  • Between 2014-15 and 2019-20, the States got ₹7,97,549 crore less than what was projected by the Finance Commission.

2) Cess and surcharge

  • Various cesses and surcharges levied by the Union government are retained fully by it, they do not go into the divisible pool.
  • This allows the Centre to raise revenues, yet not share them with the States.
  • Hence, the Union government imposes or increases cesses and surcharges instead of taxes wherever possible and, in some cases, even replaces taxes with cesses and surcharges.
  • As a result, the States lose out on their share.
  • Between 2014-15 and 2019-20, cesses and surcharges soared from 9.3% to 15% of the gross tax revenue of the Union government.
  • This systematic rise ensures that the revenue that is fully retained by the Union government increases at the cost of the revenue that is shared with the States.
  • This government has exploited this route to reduce the size of the divisible pool.

3) GST shortfall

  • Shortfalls have been persistent and growing from the inception of GST.
  • Compensations have been paid from the GST cess revenue.
  • GST cesses are levied on luxury or sin goods on top of the GST.
  • GST compensation will end with 2021-22. But cesses will continue.
  • With the abnormal exception of this year, the years ahead will generate similar or more cess revenue.
  • Hence, many States have been insisting outside and inside the GST Council that the Union government should borrow this year’s GST shortfall in full and release it to the States.
  • The Union government will not have to pay a rupee of this debt or interest.
  • The entire loan can be repaid out of the assured cess revenue that will continue to accrue beyond 2022.
  • Of the nearly ₹3 lakh crore GST shortfall to the States, the Centre will only compensate ₹1.8 lakh crore.
  • The States will not get the remaining ₹1.2 lakh crore this year.
  • In fact, it flies against the need of the hour to revive the economy.
  • Governments ought to spend money this year to stimulate demand.

4) Declining grants from the Centre

  • Central grants are also likely to drop significantly this year.
  • For instance,₹31,570 crore was allocated as annual grants to Karnataka.
  • Actual grants may be down to ₹17,372 crore.

Implications for the States

  • To overcome such extreme blows to their finances and discharge their welfare and development responsibilities, the States are now forced to resort to colossal borrowings.
  • Repayment burden will overwhelm State budgets for several years.
  • The fall in funds for development and welfare programmes will adversely impact the livelihoods of crores of Indians.
  • The economic growth potential cannot be fully realised.
  • Adverse consequences will be felt in per capita income, human resource development and poverty.
  • This is a negative sum game.

5) Loss of financial autonomy due to GST

Consider the question “What are the reasons for the declining financial health of the States in India? What are the implications for the States? Suggest the ways to deal with the issue.”


States are at the forefront of development and generation of opportunities and growth. Strong States lead to a stronger India. The systematic weakening of States serves neither federalism nor national interest.

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