Wary of Rs 15,000 Crore Revenue Loss, Karnataka to Oppose Centre’s GST Rate Cuts; Seeks Compensation

On August 25, 2025, Karnataka’s state government announced its firm opposition to the Centre’s proposed Goods and Services Tax (GST) rate cuts, citing an estimated Rs 15,000 crore annual revenue loss that could cripple the state’s finances. As part of Prime Minister Narendra Modi’s “next generation tax reforms” announced on Independence Day, the Centre aims to simplify the GST structure by reducing the current four-tier system (5%, 12%, 18%, and 28%) to a two-tier system of 5% and 18%, with a special 40% rate for luxury and sin goods. While the move promises consumer relief, Karnataka, represented by Revenue Minister Krishna Byre Gowda at the GST Council, argues it threatens fiscal stability and demands compensation or a revised revenue-sharing formula. This blog delves into Karnataka’s concerns, the proposed GST reforms, and the broader implications for India’s federal tax structure.

Karnataka’s Fiscal Concerns

Karnataka, a key contributor to India’s GST pool, projects a Rs 15,000 crore shortfall if the proposed rate cuts are implemented, a significant blow to its ambitious Rs 1.2 lakh crore GST revenue target for FY26. The state’s commercial taxes department estimates that the restructuring, which would shift many goods from the 12% and 28% slabs to 5% and 18%, respectively, could disrupt its financial planning. Karnataka’s concerns echo those of other states like Kerala, Tamil Nadu, West Bengal, and Punjab, which collectively estimate cumulative losses ranging from Rs 85,000 crore to Rs 2 lakh crore annually.

Revenue Minister Krishna Byre Gowda, Karnataka’s voice at the GST Council’s Group of Ministers (GoM) on rate rationalization, emphasized the state’s precarious position: “Karnataka supports rate rationalisation, but this exercise will leave a permanent hole in the revenues of all state governments. GST is a federal arrangement. In a federal system, no decision should be unilateral.” Gowda argued that states should not be left dependent on the Centre to sustain their budgets, especially given Karnataka’s historical revenue losses under GST, including a Rs 59,274 crore deficit over seven years due to “unscientific implementation” and an ongoing Rs 20,000–25,000 crore annual loss since 2017.

The state’s apprehension is rooted in its reliance on GST, which constitutes a significant portion of its revenue. With the compensation cess—a mechanism to offset state losses—set to expire on March 31, 2026, Karnataka fears further financial strain without a robust replacement mechanism. Chief Minister Siddaramaiah, who has previously criticized GST for undermining state autonomy, reiterated the need for compensation to continue beyond 2026, a demand echoed by opposition-ruled states in 2022.

The Centre’s GST Reform Plan

The Centre’s proposed GST overhaul aims to simplify the tax structure and boost consumption by reducing rates on consumer goods. Key changes include:

• Two-Tier Structure: Consolidating the current 5%, 12%, 18%, and 28% slabs into 5% and 18%, with a 40% rate for sin and luxury goods like tobacco, SUVs, and aerated drinks.
• Rate Reductions: Moving items like computer monitors, carbonated beverages, fruit juices, cement (currently 28%) to 18%, and readymade garments above Rs 1,000 (currently 12%) to 5%. Essential items like food and textiles are also expected to shift to the 5% slab.
• Exemptions: Removing GST on individual health and life insurance premiums, potentially costing Rs 9,700 crore in revenue.
• Expected Benefits: The Centre projects a Rs 1.98–5.5 lakh crore consumption boost, generating Rs 26,000–52,000 crore in additional GST revenue to offset losses. Lower rates are expected to reduce retail inflation by 10–25 basis points, particularly for essentials.

The Group of Ministers, including representatives from Karnataka, Kerala, Uttar Pradesh, West Bengal, Bihar, and Rajasthan, met on August 20–21 to finalize recommendations, with the GST Council set to deliberate on September 3–4. The new rates are expected to take effect by October, potentially before Dussehra.

Karnataka’s Stance: Compensation and Federalism

Karnataka’s opposition is not to rate rationalization itself but to its fiscal consequences without adequate safeguards. Byre Gowda stressed that states bear two-thirds of revenue losses due to the GST revenue-sharing formula, where states receive 50% of the State GST (SGST) and 41% of the Central GST (CGST). The state demands:

• Revenue Protection: Compensation similar to the 2017–2022 GST regime, when the Centre disbursed Rs 1,06,258 crore to Karnataka to offset losses.
• Consensus-Based Decisions: A federal approach ensuring states and the Centre agree on reforms, preserving state autonomy in a system where GST has already eroded taxing powers.
• Revised Revenue-Sharing: A formula to mitigate the disproportionate burden on states, especially high-contributing ones like Karnataka, which accounts for 9.2% of India’s GST pool.

The state’s concerns are compounded by past experiences. Since GST’s implementation in 2017, Karnataka has faced persistent revenue shortfalls, with a 20% deficit in 2018–19 and a Rs 1,260 crore loss in 2023 due to lapses in tax administration, such as input tax credit (ITC) mismanagement. The end of the compensation cess, coupled with the proposed rate cuts, could exacerbate these challenges, especially as Karnataka’s budget prioritizes social welfare and infrastructure.

Consumer Benefits vs. State Losses

The Centre’s reforms aim to put more money in consumers’ hands, with lower taxes on durables, electronics, garments, and construction materials expected to reduce prices. BT Manohar, a member of Karnataka’s GST Advisory Committee, noted, “Rationalisation of GST slabs makes economic sense, as it ensures more money in the hands of consumers, benefits trade, and increases revenue to the exchequer.” However, states like Karnataka argue that these benefits may disproportionately favor large corporates, with Kerala’s Finance Minister K.N. Balagopal estimating a Rs 8,000–9,000 crore loss for his state, particularly in automobiles and insurance.

Independent estimates paint a graver picture, with experts like Pranjul Bhandari of HSBC projecting a Rs 1.43 lakh crore national loss (0.4% of GDP), split equally between the Centre and states. CLSA’s Nikhil Gupta warned of a Rs 1.5 lakh crore annual hit, with states bearing a larger share due to revenue-sharing arrangements. SBI Research, however, is more optimistic, estimating a Rs 85,000 crore loss offset by a Rs 1.98 lakh crore consumption boost, suggesting minimal fiscal deficit risk.

Broader Implications: Federalism and Fiscal Planning

Karnataka’s opposition highlights deeper tensions in India’s federal structure. GST, introduced in 2017, was meant to unify taxation but has often been criticized for undermining state autonomy. Siddaramaiah has previously called GST an “interference” in states’ taxing powers, a sentiment echoed by Vice-President candidate Sudershan Reddy, who warned that GST reforms could “sound the death knell to federalism.”

The timing of the reforms is also critical, as states await the Sixteenth Finance Commission’s report on tax-sharing arrangements for 2026–31. With the compensation cess expiring, states like Karnataka, Punjab (facing a Rs 21,000 crore annual loss), and Kerala are pushing for a new mechanism to protect revenues. The GST Council’s upcoming meeting will be pivotal, with calls for an additional levy on sin and luxury goods to offset losses.

Conclusion

Karnataka’s opposition to the Centre’s GST rate cuts reflects a broader struggle to balance consumer benefits with fiscal stability. The projected Rs 15,000 crore revenue loss threatens the state’s ambitious welfare and infrastructure goals, prompting demands for compensation and a federal consensus. While the Centre’s reforms promise lower prices and increased consumption, the disproportionate burden on states like Karnataka underscores the need for a robust revenue protection mechanism. As the GST Council prepares to meet, the outcome will shape not only Karnataka’s finances but also the delicate balance of India’s federal tax system. The state’s stand is clear: reforms must not come at the cost of its fiscal autonomy or economic stability.

Sources:

• Times of India, August 25, 2025
• Business Today, August 26, 2025
• Mint, February 16, 2024
• The Hindu, June 30, 2022
• The Hindu, August 18, 2025
• A2Z Taxcorp LLP, August 25, 2025
• The Tribune, August 18, 2025
• CNBC TV18, August 18, 2025
• The Hindu BusinessLine, August 19, 2025
• The Financial Express, August 19, 2025
• Upstox, August 20, 2025
• Times of India, December 28, 2018
• A2Z Taxcorp LLP, August 22, 2025
• Storyboard18, August 25, 2025