The Goods and Services Tax (GST) Council is likely to consider a proposal to either impose a fresh cess on sin goods to compensate states or amend the law to raise the maximum GST rate above 40 percent, to keep the tax incidence on products such as tobacco unchanged, two government sources said.
The matter is likely to come up at the Council’s September 3-4 meeting as India moves to a two-tier rate structure with a few luxury and sin goods in the highest bracket. Tobacco currently attracts an overall incidence of about 52 percent through a mix of GST and cess, but the GST law caps the headline rate at 40 percent.
“The Council is likely to examine options to ensure states do not face a revenue shock once GST shifts to two rates. There will be a substantial revenue loss for both Centre and states. Since states’ revenues are heavily dependent on SGST, the option of a compensatory cess may be discussed. One route is a cess on tobacco; another is raising the statutory rate ceiling above 40 percent so that tobacco’s tax incidence can be maintained,” a government official told Moneycontrol.
Some states like West Bengal have already flagged concerns about potential revenue erosion from the rate rationalisation exercise, he added. According to government estimates, doing away with the 12 percent slab could entail a revenue loss of about Rs 80,000 crore, while exempting life and health insurance may result in a further Rs 9,700 crore loss.
At present, the GST framework allows a maximum rate of 40 percent. Any move to alter the ceiling would need consensus in the Council and Parliamentary approval for legislative changes. “The 40 percent cap ties our hands unless we either create a targeted cess or change the law. That will be central to the Council’s discussion,” the source said.
Excise duty option
Apart from a cess or a higher GST cap, a third option under consideration is to levy excise duty on tobacco. Since excise forms part of the divisible pool, states would receive their share through tax devolution. “Excise on tobacco is legally feasible and the proceeds devolve to states under the Finance Commission formula. It keeps the overall incidence intact while providing a predictable revenue stream to states,” a second senior government source told Moneycontrol.
The Finance Commission determines how the divisible pool of central taxes is shared between the Union government and states. The Fifteenth Finance Commission has fixed states’ share at 41 percent of the divisible pool till FY26, with allocations among states guided by factors such as population, area, forest cover, and income distance. This vertical devolution, along with GST compensation and centrally sponsored schemes, forms the bulk of fiscal transfers from the Centre to states.
Sources indicated that while a formal, statutory compensation mechanism ended post-2022, the Council may build consensus on a path that protects state revenues. “The idea is to preserve incidence on sin goods like tobacco and ring-fence state finances – whether via cess, an amended cap, or excise,” he added.
