Centre Revamps Tobacco Taxation; States Poised To Gain From Higher Excise Duty
The move shifts revenue from compensation cess—which is not shared with states—to excise duty that is part of the divisible pool, boosting states’ revenues.
The Centre’s latest move to overhaul the taxation framework for tobacco and related products is expected to significantly benefit states, as the government prepares to replace the GST compensation cess with higher excise duties and a new cess mechanism. The Central Excise (Amendment) Bill, 2025, introduced in Parliament, seeks to raise central excise duty on tobacco products, marking the first major restructuring of tobacco taxation since the rollout of GST.
Under the proposed amendment, excise duty on tobacco would rise from the existing 64% to 70%, once the new regime is notified. Unlike the GST compensation cess—which was entirely retained by the Centre to service loans taken to compensate states—excise duty is part of the divisible pool, meaning states will automatically receive a share.
Senior officials said this shift is intended not only to ensure revenue continuity as the compensation cess sunsets, but also to give states a stable, long-term revenue stream from one of the largest “sin goods” categories.
The Bill notes that with the introduction of GST in 2017, excise duty on tobacco was deliberately scaled down to make room for the compensation cess without sharply altering the overall tax burden.
The compensation cess on tobacco and allied products will be discontinued once all outstanding interest payments and loan liabilities in the cess account are fully settled, likely before March 2026.
Tobacco and its products such as cigarettes, pan masala, and gutkha currently face a 28% GST rate, supplemented by a compensation cess that can reach as high as 290% for specific items like pipe-smoking mixtures. Once the finance minister notifies the transition, these products will shift to a 40% GST slab, while remaining tax gap will be filled through a combination of the new excise duty hike and a fresh cess targeted at high-risk goods. Officials said the objective is to maintain the overall high tax incidence on tobacco—consistent with public health goals—while ensuring transparency and simplicity in the levy structure.
By moving away from a cess-dominated system to one anchored in excise and GST, the Centre is effectively broadening the flow of shared revenues to states. This shift comes at a critical juncture, as the compensation cess is set to end in March 2026.
State governments, which have long sought clarity on post-cess revenue flows, are expected to welcome the move, as it provides them with a predictable and buoyant source of revenue tied to a high-yield sector.
The Centre on Monday moved a major overhaul of the tax regime for tobacco and allied products—ranging from cigarettes and snuff to smoking mixtures and pan masala—by proposing higher excise duties and substituting the GST compensation cess with a new health and national security cess. Finance minister Nirmala Sitharaman introduced two Bills in the Lok Sabha designed to maintain the overall tax burden on these products while allowing states to gain from the shareable excise revenue.
