Pai-led research group urges Finance Commission to mandate a cap on GST cess
While chief ministers of Opposition-ruled states have pointed out the narrowing of leeway to increase indirect tax revenues after the transition to the GST regime and demanded that it be added to the divisible tax pool, chief ministers of Opposition-ruled states and the Opposition/surcharges have been a major point of contention between the Center and the States.
In a bid to address the issue, a five-member expert group of Bengaluru-based venture capital firm 3One4 Capital said limiting the share of withholding tax and surcharge in gross tax revenue could prevent their excessive use and ensure that the divisible pool retains its priority in intergovernmental resource sharing. In its 196-page proposal submitted to the 16th Finance Commission, the group proposed an upper limit of 10% of gross tax revenue. The authors of the study, commissioned by 3One4 Capital and led by the former Infosys executive, are researchers Surabhi Hodigere, Paromita Gupta, Nisha Holla and Nandish BS.
The report recommended mandatory sharing of withholding and surcharge collections above this threshold with states in proportion to their respective tax carryover rates. This ensures that states are not deprived of their fair share while the Center retains flexibility to raise targeted revenues.
“India is entering a critical phase of growth that will see nominal GDP rise from $4 trillion to $10 trillion over the next decade. The country needs a forward-looking fiscal framework that connects citizens’ needs today with India’s scale for tomorrow,” Pai said.
POPULIST PROGRAMS
The authors recommended keeping vertical devolution at 41% to strike a balance between financial support to the states and the need for central accountability. Significant requirements for infrastructure investment and rising defense expenditure across India require the Union government to retain adequate resources. Infrastructure spending provides national benefits; It increases productivity, strengthens internal cohesion and supports long-term growth in all states. At a time when many states are increasingly succumbing to populist pressures driven by political imperatives, a strong and well-resourced Center has become even more critical, the report says.
States such as Karnataka, Tamil Nadu and Maharashtra contribute disproportionately to GST collections with their large consumer bases and significant production output. Maharashtra alone produced Rs. 1,49,115 crore in State GST in 2023-2024; Tamil Nadu and Karnataka have also consistently been among the top contributors to GST. However, the consumption-based nature of GST leads to differences in revenue attribution. Therefore, states with higher income and consumption levels are legitimately entitled to a larger share of the GST revenue collected, the report argued.
Experts also pointed out that overall tax collection is not necessarily an indicator of tax generation in a particular state. For example, high corporate tax collections in a state may be due to companies having their headquarters there rather than actual business activity. Therefore, the claim that states like Maharashtra or Karnataka are ‘short-changed’ due to tax collections does not stand up to constitutional or economic scrutiny.
Impact of Demographic Change
Southern states’ long-standing concerns about fiscal devolution are exacerbated by the impending exercise of containment. After investing heavily in human development and population control, states such as Tamil Nadu, Kerala, Karnataka, Telangana and Andhra Pradesh now fear a double whammy: declining share of central resources and shrinking political representation.
While the report states that the 16th Finance Commission should directly confront this imbalance and ensure that India’s federal compact rewards results and not just numbers, it is also stated that the Constitution is based on the principle of equality for every citizen, and that every citizen has an equal right to the country’s tax resources.
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