In 2017, Indian states did something unprecedented in the history of fiscal federalism globally: they surrendered their most productive taxes—value added tax, entry tax, octroi and others—to a collective body in exchange for the idea of ‘one nation, one tax.’
The price of that surrender was written into the Goods and Services Tax (Compensation to States) Act of 2017; it protected state revenue at 14% compound annual growth for five years, funded by a GST cess on sin and luxury goods.
The promise was politically elegant. The arithmetic less so. Cess collections fell behind the guarantee even before the pandemic and covid widened the gap dramatically. The Centre eventually borrowed ₹2.69 trillion across two fiscal years to meet compensation obligations that the cess could not fund.
The five-year levy was subsequently extended until March 2026 to service that debt. A transitional instrument had become a debt-repayment mechanism. With the loans repaid ahead of schedule, the cess expired on 31 March 2026.
For the first time since GST was introduced in India, states are fully exposed to their own performance. There is no guaranteed growth rate, compensation mechanism or shortfall insurance. Their fiscal position depends on a tax whose rates are determined collectively by a GST Council where the Centre holds one-third of the votes and an effective veto.
Meanwhile, the divisible pool of taxes has been constrained by the growing use of cesses and surcharges outside it. With these excluded, only about 81% of the Centre’s gross tax revenue was shareable in 2025-26.
This is the central asymmetry in India’s post-GST fiscal architecture. States gave up significant taxation powers, while the protection that accompanied that surrender had a sunset clause. Their expenditure responsibilities did not.
India’s GST rate reform of September 2025 sharpened that exposure. GST 2.0 reworked the rate structure, but rate reductions also reduced the tax base that states share. Several states sought the Centre’s estimate of the resulting revenue loss and asked for continued compensation. They received neither.
Further, there is a longstanding case to bring petrol, diesel, aviation turbine fuel and natural gas into GST’s fold, alongside alcoholic drinks. Petroleum products already sit within the GST framework but await a Council-recommended date, while liquor requires a Constitutional amendment. Stamp duty is another question that involves deeper institutional change.
But the more important question is whether these taxes should be brought into GST before the fiscal bargain underlying GST is renewed.
These levies are among the last significant tax handles over which state governments retain direct discretion. Taking them away without a durable replacement would further separate the responsibility of spending from the power to raise revenue, weakening both fiscal agency and accountability.
The completion of GST’s tax map, thus, cannot precede the renewal of its federal bargain. A new compact would require three rules.
One, India needs a revenue-floor mechanism for states. A formula-based stabilization fund, triggered when state GST revenues fall below a defined band, could provide states insurance without an open-ended commitment.
Second, there must be discipline over the divisible pool. The 16th Finance Commission retained the share of states at 41% of the divisible pool, but did not recommend a cap on cesses and surcharges. Parliament should consider a statutory ceiling on non-shareable levies so that devolution isn’t diluted.
Third, borrowing autonomy needs reconsideration. A state operating within its fiscal-responsibility targets should be able to access the market on its own credit and risk-adjusted spread, without Article 293 consent becoming an annual instrument of administrative persuasion. Markets can price fiscal risk and reward discipline. A mature federation should use that discipline instead of ministerial discretion.
The principle is straightforward. The more taxation powers states surrender, the more important it becomes that they retain fiscal capacity and agency. The big question, thus, is constitutional as much as economic: what does India owe its states for the tax sovereignty they surrendered?
Fiscal federalism is not a favour by the Centre to states. It is an institutional compact in which both levels of government must retain the capacity to govern and accountability for it. If India wants GST to fulfil its promise, it should first complete the federal bargain that made it possible.
The authors are, respectively, a corporate advisor and author of ‘Family and Dhanda’; and a Supreme Court advocate and former IRS officer.