Protecting revenue: GST may need further reforms to safeguard collections

Govt hikes excise on tobacco, levies pan masala cess amid tepid GST growth, raising concerns over divisible pool

The Union government this week introduced two Bills in Parliament to enable it to impose taxes on select sin goods. In a way, this is a logical step forward after the rationalisation of rates in goods and services tax (GST). In September, the GST Council had decided to move broadly to a two-slab system of 5 per cent and 18 per cent. Besides, select sin and luxury goods were put in the 40 per cent tax slab. The adjustment also ended the compensation cess on most items, except sin goods, on which it was retained to repay the remaining debt incurred to compensate states for the revenue shortfall during the pandemic. As the debt gets fully repaid, the new Bills will ensure that taxes on sin items do not decline. 

As the statement of objects and reasons for the Central Excise (Amendment) Bill, 2025, explains that with the levy of GST and the compensation cess on tobacco and tobacco products, central excise rates were reduced significantly. Now that the cess will be discontinued once the debt incurred to pay compensation is fully repaid, the government is increasing the excise duty. Further, the Health Security Se National Security Cess Bill, 2025, will enable the government to levy a cess on machines used to produce specified goods, such as pan masala or other items, which may be notified later. Cess collection is intended to be utilised for public health and national security. Since this will be a cess, the Centre will not be required to share it with the states. Notably, the simplification of the GST system was welcomed by most stakeholders. In the same reformist spirit, the government could simply have imposed a sin tax over and above the GST rate on items it deemed fit. This would have kept the tax structure simple, and the collection, like all other central taxes, could have been shared with the states. The imposition of the cess must be avoided. State governments in this regard have a genuine concern that the increasing dependence on cess collection affects the flow of tax revenue because that is not part of the divisible pool. Ideally, it should be imposed only as a temporary measure in exceptional circumstances. 

Although the new Bills will help protect revenue to some extent, GST collection may settle at an unfavourable level. Net GST collection in November increased just 1.3 per cent, year-on-year, without factoring in the compensation cess. One way to see the numbers is that despite reduction in GST rates on most items, collection has not dropped. However, it is worth noting that the collection reflects the surge in demand during the festival season after the rate cuts. It needs to be watched if demand sustains over the coming months. A possible reduction in GST collection will affect both the Union government and the states. As things stand, the Union government’s gross tax revenue increased only 4 per cent, year-on-year, during April-October and will have to grow at a much faster rate to achieve the full-year revenue target. Things could become difficult if GST collection drops in the coming months. In this regard, once cess collection ends and a clearer picture of revenue collection emerges, the GST Council could deliberate on the next set of reforms. Further rate adjustments may be necessary to safeguard revenue over the medium to long run.