The GST Council and cooperative fiscal federalism

Detail

1. Key terms first

• Fiscal federalism: how taxing powers, spending duties and money transfers are split between the Centre and the states.
• Cooperative federalism: the Centre and states decide together on shared matters, as partners.
• Competitive federalism: states compete with each other for investment, rankings and good governance.
• Goods and Services Tax (GST): one tax on the supply of goods and services. It replaced many separate central and state indirect taxes. It has three parts:
• CGST: the Centre collects it on sales inside one state.
• SGST: the state collects it on sales inside that state.

• IGST: the Centre collects it on sales from one state to another, then shares it with the state where the buyer is.

• Art. 246A (added by the 101st Amendment, 2016): gives Parliament and state legislatures simultaneous (both at the same time) power to make GST laws. Before this:

• the Centre alone taxed services and manufacturing (excise);
• the states alone taxed the sale of goods (VAT) [7].

2. Structure of the GST Council (Art. 279A, 101st Amendment 2016)

• Birth: the Union Cabinet approved setting up the GST Council and its Secretariat in 2016. The first meeting was held on 22–23 September 2016 in New Delhi [4].
• Members:
• the Union Finance Minister (chair);
• the Union Minister of State for Finance;
• the finance minister (or a nominated minister) of each state.

• For GST purposes, "state" also covers Union Territories with a legislature (Art. 366(26B)).

• Quorum (the smallest number of members who must attend for a meeting to be valid): one-half of all members.

• Voting (weighted voting): votes do not count equally. Each side gets a fixed weight.
• A decision needs at least three-fourths (75%) of the weighted votes of members present and voting.
• Centre: one-third (33.3%) of the votes.
• All states together: two-thirds (66.7%), split equally among the states present.

• So neither side can pass a proposal alone.

• Worked example (all members present):

• States alone: 66.7% < 75%. They fail. The Centre in effect has a veto (the power to block).
• Centre alone: 33.3% < 75%. It fails.
• Centre + states: the Centre needs 75 − 33.3 = 41.7 percentage points from the states.
• 41.7 ÷ 66.7 = 62.5%. So at least 62.5% of the states present and voting must agree.

• If more than 37.5% of the states' weight votes "no", the proposal fails. States as a group can also block.

• What it recommends (Art. 279A(4)):

• taxes, cesses and surcharges to be subsumed (merged into GST);
• goods and services to be taxed or exempted;
• model GST laws and place-of-supply rules (rules that decide which state gets the tax);
• threshold limits (the turnover below which a business need not register);
• rates, including floor rates with bands;
• special rates for a limited time to raise extra money during a disaster;
• special provisions for NE and hill (Himalayan) states [7];
• how IGST is shared [7];

• the date for bringing petroleum into GST. Crude, diesel, petrol, natural gas and ATF are constitutionally inside GST, but they carry "zero GST" until the Council sets a date.

• Art. 279A(11) provides for a dispute-settlement mechanism for fights between the Centre and states, or among states. It has never been set up.

3. Legal status: Union of India v. Mohit Minerals (SC, May 2022)

• The case: the Court looked at IGST charged on ocean freight under the reverse-charge rule. It asked whether the Council's recommendations bind governments.
• Holding: the Council's recommendations are persuasive, not binding.
• Why:
• Art. 246A gives Parliament and state legislatures simultaneous power.
• So neither the Centre nor a state is bound to follow the Council.

• Art. 279A says the Council "recommends". It does not say the Council "decides".

• The Court described the Council as a forum of cooperative (and contestational) federalism.

• Contestational federalism: states can openly disagree, bargain and push back. This conflict is part of a healthy federation.

• Practical effect: in real life the Centre and states still follow Council decisions. A state that breaks away would put the common market at risk.

4. Pooled sovereignty

• Pooled sovereignty: states give up part of their separate tax power and put it into a shared pool run jointly with the Centre.
• What states gave up: VAT/sales tax, entry tax, entertainment tax, luxury tax, and the freedom to set their own rates.
• What the Centre gave up: its separate central excise (on most goods) and service tax [7].
• What states got in return: a share of a single national tax base.
• Class 12, Government Budget and the Economy (Box 5.3) calls this "One Nation, One Tax, One Market".
• GST replaced central and state taxes including VAT, entry tax, luxury tax, octroi and entertainment tax.

• It "created a common market".

• State GST (SGST) is now states' largest own tax.

• Trade-off:
• Gain: one tax base, less cascading (tax charged on top of tax), smoother trade between states.

• Loss: a state can no longer change a rate by itself to raise money.

• Early concern about the Centre's power: under the 2017 CGST law, the Centre could notify CGST rates up to 20% without Parliament's approval. Income-tax rate changes, by contrast, need Parliament to approve them [7].

5. Compensation: the federal bargain

• Why compensation was needed: GST is a destination-based tax. The tax goes to the state where goods are consumed, not where they are made. So manufacturing states such as Maharashtra, Gujarat and Tamil Nadu feared they would lose revenue.
• GST (Compensation to States) Act 2017:
• States were guaranteed 14% annual growth in GST revenue.
• Base year: 2015-16.
• Period: five years (July 2017 to June 2022).
• Paid from the compensation cess. A cess is an extra tax raised for one stated purpose. It goes to a separate fund and is not shared through the Finance Commission formula.

• Any cess left unused at the end was to be split 50:50 between the Centre and states. This differs from the Finance Commission sharing formula [7].

• How the guarantee worked (with numbers):

• Protected revenue in year n = Base-year revenue × (1.14)ⁿ
• Compensation = Protected revenue − Actual GST revenue

• Example: a state earned ₹10,000 crore in 2015-16. Protected revenue for year 2 = 10,000 × 1.14² = ₹12,996 crore. If actual revenue was ₹11,500 crore, compensation = ₹1,496 crore.

• The 2020 shortfall (COVID):

• Cess collections fell. They could not cover compensation.
• After a dispute, the Centre borrowed through a special borrowing window. It passed the money to states as back-to-back loans (the Centre borrows, then lends the same money to states; states do not repay from their own budgets).
• ₹1.1 lakh crore in FY 2020-21 + ₹1.59 lakh crore in FY 2021-22 = ₹2.69 lakh crore [5].
• These loans are repaid from future cess collections.

• The Centre extended the cess beyond 5 years to cover the revenue gap and repay these loans [5].

• Loan recovery from the GST Compensation Fund:

• ₹78,104 crore recovered in FY 2023-24 [6].

• ₹1,23,604 crore recovered in FY 2024-25 [6].

• Compensation ended in June 2022. The cess was extended to March 2026 to repay the loans.

6. The 56th GST Council (3 September 2025): "GST 2.0"

• Rate rationalisation: the Council moved to a two-rate structure [2]:
• Merit rate: 5%
• Standard rate: 18%
• Special demerit (sin-good) rate: 40% for a few goods and services. This rate includes the old compensation cess, so the total tax burden does not rise [2].

• The old 12% and 28% slabs were mostly removed.

• Examples:

• Small cars: 28% → 18%. Small car means petrol/LPG/CNG up to 1200 cc, or diesel up to 1500 cc, with length up to 4000 mm [2][3].
• Mid-size and large cars: 40%, with no compensation cess [3].
• Motorcycles: up to 350 cc → 18%; above 350 cc → 40% [3].
• Bicycles and their parts: 12% → 5% [3].

• Coal: compensation cess removed, and GST raised 5% → 18% [9].

• Effective date: 22 September 2025 for most goods and services [2].

• Compensation cess ended for most goods. The cess rate was merged into GST rates to keep the same tax level [2].
• Tobacco: the exception (the scaffold asked to verify this):
• For cigarettes, chewing tobacco (zarda), unmanufactured tobacco and beedi, the old GST + compensation cess rates continued [3].
• New rates will apply only after all the loan and interest dues on compensation cess are fully repaid. The date is to be notified [3].
• To keep the tax level the same after the cess ends, Parliament passed the Central Excise (Amendment) Bill, 2025 (passed by Lok Sabha on 3 December 2025 and by Rajya Sabha on 4 December 2025) [8]. It raised central excise on tobacco, for example [8]:
  • Cigarettes: ₹200–735 → ₹2,700–11,000 per thousand sticks
  • Chewing tobacco: 25% → 100%
  • Unmanufactured tobacco: 64% → 70%

• Federal angle: basic central excise is part of the divisible pool (Art. 270), so states get a share through Finance Commission devolution. The compensation cess worked differently.

• States' concern: states raised revenue-loss concerns. Lower rates on many goods could cut SGST collections, and compensation has ended (PRS flags adverse SGST impact) (verify current).

7. Friction points

• IGST settlement delays: IGST is collected by the Centre and later passed to the consuming state. Delays or errors hold up states' cash.
• Petroleum and alcohol outside GST:
• Alcohol for human consumption is kept outside GST by the Constitution.
• Petroleum stays at "zero GST" until the Council fixes a date.

• States want to keep these two big sources of their own revenue.

• Heavy dependence on GST: a large share of states' own tax revenue now depends on decisions taken in a room where the Centre holds a veto.

• Loss of rate-setting freedom: a state cannot raise rates alone to fund its own priorities.
• Compensation politics: the 2020 shortfall and the end of compensation in 2022 tested trust between the Centre and states.
• No dispute body: the Art. 279A(11) mechanism was never set up, so disputes go to the courts or stay unresolved.
• Cess vs. divisible pool: money raised as cess does not go to states through the Finance Commission formula. This is a long-running state complaint [7].

8. The lens: cooperative vs competitive federalism

• Cooperative: the Centre and states decide together.
• GST Council (joint decisions, weighted voting)
• NITI Aayog Governing Council (the PM, all Chief Ministers and UT Lieutenant Governors)

• The "Team India" framing

• Competitive: states compete through NITI Aayog rankings and indices (e.g., SDG India Index, Export Preparedness Index).

• Where the GST Council fits: mainly cooperative. Mohit Minerals adds that it is also contestational, a place where states can bargain and disagree.
• GST rates and mechanics are covered in the taxation topic.

Prelims Hooks

• The GST Council was created by Art. 279A, inserted by the 101st Constitutional Amendment Act, 2016. Its first meeting was held on 22–23 September 2016 [4].
• Chair: Union Finance Minister. The Union MoS Finance is a member. The Union Minister of State for Revenue is not named in Art. 279A (a common trap).
• Quorum = one-half of members. Decision = at least three-fourths of the weighted votes of members present and voting.
• Weights: Centre 1/3, all states together 2/3. Neither side can pass a proposal alone. Both can block.
• Art. 246A gives simultaneous GST law-making power to Parliament and state legislatures.
• Union of India v. Mohit Minerals (SC, May 2022): Council recommendations are persuasive, not binding.
• The dispute-settlement mechanism under Art. 279A(11) has never been set up.
• Compensation Act 2017: 14% yearly growth, base year 2015-16, 5 years (July 2017 to June 2022). Back-to-back loans = ₹1.1 lakh crore (2020-21) + ₹1.59 lakh crore (2021-22) [5].
• 56th Council (3 September 2025): slabs of 5% / 18% / 40%, effective 22 September 2025. Compensation cess ended for most goods, but continued on tobacco until the loans are repaid [2][3].
• The 40% demerit rate already includes the old compensation cess [2].

Mains Points

• Pooled sovereignty and state autonomy (GS-II):
• Gains: GST built a common national market and cut cascading.
• Costs: states lost rate-setting freedom, and the Centre holds a de facto veto (its 1/3 weight against a 75% threshold).

• Mohit Minerals restores balance by making recommendations persuasive, but it also risks legislative disagreement between the Centre and states.

• Compensation as a test of trust (GS-II/III):

• The 14% guarantee drew states into the deal.
• The 2020 shortfall (paid through ₹2.69 lakh crore of back-to-back loans [5]) and the end of compensation in June 2022 exposed states' revenue risk.
• The 2025 rate cuts renewed SGST worries.

• Ways forward: a permanent revenue-stabilisation fund, or a larger devolution share.

• Cess vs devolution (GS-III):

• Cesses sit outside the Art. 270 divisible pool.

• Replacing the tobacco compensation cess with central excise (Central Excise (Amendment) Bill, 2025 [8]) brings that money back into the shareable pool. It shows how the choice of tax instrument changes the Centre-state split.

• Unfinished agenda:

• Set up the Art. 279A(11) dispute body.
• Bring petroleum into GST in stages, with protection for states' revenue.
• Make IGST settlement faster and more transparent.
• Together these would move GST from "contestational" to fully cooperative federalism.