- Three years ago, the Centre and the States of the Union of India struck a grand bargain resulting in the launch of the unified Goods and Services Tax (GST) era.
About Goods and Services Tax
About GST Council
Post GST era:
- The States gave up their right to collect sales tax and sundry taxes, and the Centre gave up excise and services tax.
- The nationwide GST promised frictionless commerce across State borders, buoyant and leakproof tax compliance, and removal of inefficiencies like the cascade of “tax on tax”.
- It was the result of painstaking consensus building, which inter alia involved addressing the apprehension of States, of revenue loss due to the GST.
Abdication of responsibility
- Prior to GST, States exporting goods to other States collected a tax. GST is a destination-based tax, i.e., the State where the goods are sold receive the tax. This implies that manufacturing States would lose out while consuming States would benefit.
- Their consent was secured by a promise of reimbursing any shortfall in tax revenues for a period of five years. This reimbursement was to be funded by a special cess called the GST compensation cess.
- The modalities of the compensation cess were specified by the GST (Compensation to States) Act, 2017. This Act assumed that the GST revenue of each State would grow at 14% every year, from the amount collected in 2015-16, through all taxes subsumed by the GST.
- A State that had collected tax less than this amount in any year would be compensated for the shortfall.
- The amount would be paid every two months based on provisional accounts, and adjusted every year after the State’s accounts were audited by the Comptroller and Auditor General.
- This scheme is valid for five years, i.e., till June 2022.
Compensation cess fund
- A compensation cess fund was created from which States would be paid for any shortfall.
- An additional cess would be imposed on certain items like Pan masala, cigarettes and tobacco products, aerated water, caffeinated beverages, coal, certain passenger motor vehicles and this cess would be used to pay compensation.
- The Act states that the cess collected and such other amounts as may be recommended by the [GST] Council would be credited to the fund.
- In the first two years of this scheme, the cess collected exceeded the shortfall of States.
- In the third year, 2019-20, the fund fell significantly short of the requirement (the total compensation was Rs. 1,65,302 crore while the compensation cess fund collected was Rs. 95,444 crore)
- This was on account of slowdown in tax collections as the economy slowed down coupled with negative growth in sectors such as motor vehicles which contributed to the cess fund.
- This raises the question of how the compensation will be made in the current year.
Challenges before the states during pandemic
- The tax collection has dropped significantly, while expenditure needs are sharply higher, especially at the frontline of the battle, at the State level.
- States have been told that they are on their own to meet the shortfall in revenues.
- Using an equivalent of the Force Majeure clause in commercial contracts, the Centre is failing to fulfill its responsibility of making up for the shortfall in 14% growth in GST revenues to the states.
(Force Majeure is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled)
Why is the onus on the Centre?
- States do not have recourse to multiple options that the Centre has, such as issue of a sovereign bond (in dollars or rupees) or a loan against public sector unit shares from the Reserve Bank of India.
- The Centre can anyway command much lower rates of borrowing from the markets as compared to the States.
- In terms of aggregate public sector borrowing, it does not matter for the debt markets, nor the rating agencies, whether it is the States or the Centre that is increasing their indebtedness.
- Fighting this recession through increased fiscal stimulus is basically the job of macroeconomic stabilisation, which is the Centre’s domain.
Widening of tax base
- GST is a destination-based consumption tax, which must include all goods and services with very few exceptions, such as food and medicine.
- That widening of the tax base itself will allow us to go back to the original recommendation of a standard rate of 12%, to be fixed for at least a five-year period.
- A low moderate single rate of 12% encourages better compliance, reducing the need to do arbitrary classification.
Make space for state’s revenue
- Some extra elbow room for the States’ revenue autonomy is obtained by allowing the States non VATable surcharges on a small list of “sin” goods such as liquor, tobacco, polluting goods such as sport utility vehicles, and industrial fuels such as diesel, aviation turbine fuel and coal.
Sharing with the third tier of government
- Of the 12% GST, 10% should be equally shared between the States and the Centre, and 2% must be earmarked exclusively for the urban and rural local bodies, which ensures some basic revenue autonomy to them.
- The actual distribution across panchayats, districts and cities would be given by respective State Finance Commissions.
Extend cess beyond 5 years
- Centre could borrow on behalf of the cess fund. The tenure of the cess could be extended beyond five years until the cess collected is sufficient to pay off this debt and interest on it.
Reset growth target
- The growth target should have been linked to nominal GDP growth. If the Centre can negotiate with States through the GST Council to reset the assured tax level, it could then bring in a Bill in Parliament to amend the 2017 Act.
- GST is a crucial and long-term structural reform which can address the fiscal needs of the future, strike the right and desired balance to achieve cooperative federalism and also lead to enhanced economic growth.
- A new grand bargain is needed to deliver that promise which the current design and implementation has failed to deliver.