Context

India has completed five years under the GST regime.

How GST has performed so far

• Before the GST, there were multiplicity of the Centre and state levies that masked the actual incidence of tax on products, the debilitating effects of the entry tax and the uncertainty of tax rates.
• Today, in contrast, we have a single tax across the country combined with a stability in rates and a common technology platform in the form of a GSTN.
• Record number of registrants: The ease of payments has improved over time with the technical glitches having been slowly sorted out, leading to a record number of GST registrants – increasing from 1.08 crore in April 2018 to 1.36 crore in 2022.
•  The revenue gains have been significant.
• If we factor in the three-percentage point decline in the incidence of GST duty from 14.8 to 11.8 per cent as suggested by the RBI, the actual proportion in 2021-2022 would have been 7.4 per cent of the GDP (according to a recent article by Arvind Subramanian and Josh Felman).

What were the changes made to ensure the stricter compliance

• The above improvement can be traced to stricter compliance flowing from three factors.
• 1] Input credit only after supplier uploads invoice: Denial of input credit to the buyer without the supplier uploading the invoice.
• 2] The introduction of e-invoicing.
• 3] Third the introduction of e-waybills for transporters for value exceeding Rs 50,000 per consignment.
• Greater coordination between CBIC and CBDT: Another factor is greater coordination between the Central Board of Excise and Customs (CBIC) and Central Board of Direct Taxes (CBDT) in compliance verification.

Changes needed

• 1] Provisions for unregistered GST suppliers: The micro, small and medium enterprises (MSME) sector has been affected by the GST reforms because the large units have been reluctant to buy from them in the absence of input duty credit.
• An important measure here would be to amend the law to provide that all units buying from unregistered GST suppliers would have to pay duty on a reverse charge basis.
• 2] Rate rationalisation: While the revenue gains have come through better compliance, the next surge in GST revenues will have to come from an increase in the average incidence of GST duties.
• This will require a combination of measures — phasing out of exemptions, raising of the merit rate from the present level of 5 per cent and merging the 12 per cent rate with the standard rate, whether to 16 per cent or 18 per cent.
• 3] Inclusion of fuels and real estate: Including natural gas/ATF under GST should be considered.
• Further reforms in the factor markets — land, real estate and energy — would require their inclusion in the GST.
• This is essential because while the economic reforms of the 1990s restructured the product market, the factor market reforms were incomplete.
• 4] Creation of federal institution: We need to create another institution in the form of a GST state secretariat that can bring together senior officers from the Centre and states in an institutional forum registered under the Society Act.
• This forum could also provide a common point of contact for trade and industry to redress the grievances on non-policy matters.

Conclusion

As GST enters its sixth year journey, the changes suggested above will fine tune it to propel India towards $5 trillion economy.

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Back2Basics: GST Input Tax Credit

• Input Tax Credit means claiming the credit of the GST paid on purchase of Goods and Services which are used for the furtherance of business.
• The Mechanism of Input Tax Credit is the backbone of GST and is one of the most important reasons for the introduction of GST.

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Context

There has been a remarkable upswing in GST collections in recent months. Collections touched a record high of Rs 1.67 lakh crore in April.

GST

What are the reasons for increased collection?

• 1] Inflation: First, the sharp rise in inflation has played a significant role.
• Notwithstanding concerns over the unevenness of the economic recovery, in nominal terms, the economy grew by 19.4 per cent in 2021-22 as per the second advance estimates.
• Deflating GST collection suggests that a large part of the recent increase in collections is driven by rising prices.
• 2] Higher imports: Part of the overall increase in collections can be traced to higher imports.
• Higher buoyancy: Even if one is to exclude the revenue accruing from imports, the rise in GST collections has outstripped GDP growth, indicating higher buoyancy.
• 3] Tightening of the rules: In order to improve compliance levels, the GST Council has been tweaking the rules to tighten the system.
• Returns filed have gone up, while the number of non-filers and those who delay filing have fallen.
• Alongside, the administration has also taken steps to tackle the menace of fake invoices by placing restrictions on the quantum of input tax credit that can be used to pay of tax obligations.
• The introduction of e-invoicing has also played a role.
• Until recently, this was being implemented for firms with a turnover of more than Rs 50 crore.
• From April, this process has been extended to firms above Rs 20 crore.
• The incremental gains from bringing smaller firms into its ambit, while consequential, are unlikely to be of the same order.
• 4] Industrial activity:  The higher collections in April 2022 seem to be led by increase in industrial activity. This is borne by strong growth in collections in states such as Maharashtra, Karnataka and Odisha which house lot of industries. Relatively tepid growth in more populous states such as Bihar (-2.47 per cent), West Bengal (7.80 per cent) and Jharkhand (4.86 per cent) shows that the GST collections was not propelled by revival in private consumption.
•  The real challenge lies in improving compliance levels across the entire spectrum of industries where inputs/raw materials are sourced largely from the informal sector.
• 5] Changing the structure of the economy: The formalisation of firms, the growing concentration of economic power in the hands of a few, imply that for the same level of output, the tax paid will be higher.

Suggestion

• Increase tax rate: Around two-fifths of the taxable value (or turnover) falls under the 18 per cent slab as per research by some analysts.
• This implies that simply merging the 12 per cent and the 18 per cent slab as some have been suggesting would lead to a revenue loss.
• Before opting for such adjustments, the GST Council must first ascertain the potential revenue (net of cess and refunds) at varying levels of compliance, tax rates and exemptions afforded.
• Now, as per some estimates presented to the 15th Finance Commission, with existing exemptions in place, the current tax regime should ideally yield revenues equivalent to 8.23 per cent of GDP.
•  In another scenario, even if existing exemptions are kept in place, and if a single rate of 14 per cent is levied, then collections should rise to 8.93 per cent.

Conclusion

Considering the current economic situation, now may not be an opportune moment to raise taxes. But there is no getting around it. Both the Centre and the states need to work towards this.

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Context

Seen purely from a revenue point of view and as a fiscal policy tool, India’s GST is still on a rocky road.

Background

• The GST was launched by India on the midnight of July 1, 2017.
• Benefits of GST: Hailed as a landmark reform in India’s tax history, it was expected to improve tax-GDP ratio, end tax cascading, enhance efficiency, competitiveness, growth, and ensure lower prices.
• Fiscal federalism: It was also projected as a watershed in India’s fiscal federalism.
• the States have forgone a substantial part of their own tax revenue.
• States were in turn guaranteed a GST compensation assuring 14% growth in their GST revenue during the initial five years.
• India’s GST architecture: India’s GST architecture is built on the firm foundations of a GST Council and the GST Network (GSTN).
• GST Council as due federal process: The first is the key decision-making body, chaired by the Union Finance Minister with a Minister of State in charge of Finance and the Finance Ministers of States as members.
• This is envisaged as a due federal process to protect the interests of the States.

Unresolved issues

[1] Revenue neutrality not achieved

• India’s GST paradigm stands on two key pillars: revenue neutrality and GST compensation for the States.
• The assured revenue neutrality remains a mirage and many States have experienced a declining tax-GDP ratio.
• Decline in tax to GDP ratio of state: In the case of major 18 States, the ratio of own tax revenue to GDP has declined.
• While the share of the Centre in total GST increased by 6%, that of States put together lagged behind with only a 4.5% increase.
• Stark differences between the Revenue Neutral Rates (RNR) for the producing States and consumption State have been observed. States producing exempted food grains also lost out.
• Since the rates were lower under GST vis-à-vis the VAT regime, revenue neutrality was not adhered ab initio.
• The problems were compounded with massive evasion following the dismantling of check posts, and later on fake invoices, that grew by leaps and bounds.
• Experience of other countries: The South African experience illustrates how zero-rating and large exemptions have defeated revenue goals.
• Canadian experience shows that GST could be improved by limiting zero rating, tax-exemptions and harmonising tax rates.
• The resilience of the economy at the time of rolling out of GST is critical for its wider reception as the Australian experience shows.

[2] Not conducive to co-operative federalism

• While the States collectively forewent 51.8% of their total tax revenue, the Centre surrendered only 28.8%.
• Yet, GST is shared equally between the Centre and States despite two expert committees recommended for a higher share for the States.
• Given the revenue neutrality failure and the host of other issues, many of the States are left with no option except to depend on GST compensation.
• This is not conducive to sustainable co-operative federalism.

[3] Need for revenue sharing formula for IGST

• Although IGST is a key source of revenue for many of the States, the clearing house mechanism and the process therein remains unknown territory.
•  It was pointed out that GST is discriminatory to manufacturing States, indicating the need for a revenue sharing formula that duly incentivises exporting States by sharing IGST revenue among three parties instead of two.

[4] Other issues

• Swift functioning of Input tax credit: The Malaysian experience demonstrates the need for swift and transparent functioning of the input tax credit system through a flawless IT infrastructure.
• We operate in an almost information vacuum especially with respect to IGST along with several glitches in the digital architecture.
• GSTN is now in the doldrums.
• Data monopoly: It neither makes effective use of the massive and invaluable data being generated nor shares them to enable others to make use of them.
• Such practice in “data monopoly” was a fact of history in India’s statistical system and has to go sooner rather than later.
• Australia, having several similarities with India, in terms of Centre and the subnational units, and destination-based, multi-stage tax with input credit provisions, has not been revenue-buoyant.
• It is a matter for consideration whether widening exemptions and the replacing of income-tax by GST in the case of small and medium enterprises are advisable measures in the Indian context.

Consider the question “What are the challenges facing the GST in India? What India can learn from the experience of other countries’ experience.”

Conclusion

Despite many years of efforts in evolving an Indianised GST system and over 50 months of adjustments with over a thousand notifications, with accompanying uncertainties in the first year and the novel coronavirus pandemic and the lockdown still in the saddle, GST continues to be an unfinished agenda. But how far and how long?

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Context

The Centre is facing a serious financial crisis because of the exigencies created by the pandemic and its own policies. However, monetising assets and cutting down funds to states could aggravate the crisis.

3 Policies aggravating the crisis

1) NMP and disinvestment

• Union Finance Minister, while announcing the National Monetisation Pipeline (NMP), said that asset monetisation is based on the philosophy of creation through monetisation and is aimed at “tapping private sector investment for new infrastructure creation”.
• Loss of dividend: Disinvestment of profitable Navratna companies will result in a loss of dividend, a major source of income for the Centre.
• Loss due to tax exemptions: Tax exemptions to the investors will take away another major share of income.
• Central funds will be squeezed and this, in turn, will have a bearing on state finances.
• NMP will seriously hurt the interests of the country.

2) Cutting down funds to States

• Kerala’s case: The state was getting about 3.92 per cent from the divisible pool in the 1970s and 1980s.
• It came down to 2.66 per cent and 2.34 per cent in the awards of the 12th and 13th Finance Commissions.
• The 14th Finance Commission award increased it to 2.45 (2.50) per cent.
• Now, the 15th Finance Commission has reduced it to 1.92 per cent.
• This arbitrary cut is a result of the adoption of certain new yardsticks by the commission without considering the state government’s views
• The 15th Finance Commission’s special grant (RD grant) of Rs 19,800 crore for this year will no longer be available in the coming years.
• Karnataka and many other states have also suffered because of the policy to reduce the divisible pool share.

3) Tax exemptions and surcharge

• Exemptions amounting to Rs 99,842.06 crore were extended to corporate houses in 2019-20.
• Many taxes on goods were reduced because of electoral compulsions. This reduced central revenues.
• Along with such tax exemptions, the increased use of cesses and surcharges is responsible for the shrinking of the shareable pool.
• The shareable resources with the Centre was around Rs 6.8 lakh crore in 2019-20 which has come down to Rs 5.5 lakh crore in 2020-21.
• All the cesses and surcharges that are not shared with states come to about 20 per cent of the total revenues of the Centre.
• States have been demanding that this money should be shared with them, particularly while fighting a pandemic.
• States complaining for resources does not augur well for cooperative federalism.

Way forward

• Developing basic infrastructure and the production sector is the only way to face an economic crisis.
• That should not be done by selling or handing over public assets to private individuals and corporations.
• We need massive public investment that will help people to form cooperatives and collectives in agriculture and industrial production.
• Parliament, the National Development Council and the GST Council should discuss this unprecedented situation.

Conclusion

We need to find a way out collectively. Handing over the rights on public properties to private individuals will take the country back to the colonial era. This must not be allowed.

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The article highlights the issues with the one state one vote system adopted in the GST Council decision making.

Context

The Goods and Services Tax (GST) Council in India is still engaged in a discussion on whether life-saving and hard-to-come-by products should be taxed. Such delay in decision-making can largely be explained by the distorted design and incentive structure of the GST itself.

Imbalance in collection and distribution of taxes

• The taxes collected under GST are accumulated by the Union government and a portion is transferred back to each state under a formula.
• As is the case with most federal countries, there is a large imbalance in the collection and distribution of taxes between states.
• this holds true also for income accrued to, and distributed, from the GST pool.
• Four states — Maharashtra, Tamil Nadu, Karnataka, and Gujarat contribute nearly as much as the remaining 27 states combined.
• Most federal countries exhibit this characteristic where a few large, rich, provinces or states contribute disproportionately.

Variation in dependence of States on transfers from the Union government

• Only about 30 per cent of the overall revenue of the states mentioned above — Maharashtra, Tamil Nadu, Gujarat, and Karnataka — comes from the Union government.
• But for the remaining 27 states, roughly 60 per cent of their revenues are obtained through transfers from the Union government.
• For the smaller Northeastern states, these transfers from the Union government constitute 80-90 per cent of their total revenues.
•  In effect, the states that contribute the most to the GST pool are the least dependent on transfers from the Union government while the ones that contribute the least are the most dependent.

Two problems in net-transfers in India

1) One-sided transfers

•  In almost every federal union, net-transfers work to reduce differences in development between states over time.
• However, Over the last 25 years or so, net transfers have become increasingly one-sided in India.
• That is, the quantum of net-transfers diminishes, as states become more equal through such transfers.
• But in India, the opposite has occurred.

2) Indirect taxes and cess

• The Union government of the last seven years has greatly exacerbated this problem through two actions.
• First, it has reconstructed the composition of taxation away from the fair and progressive channel of direct taxation towards the inherently regressive and unfair channel of indirect taxes.
• Second, the Union has shifted a large proportion of taxation roughly 18 per cent of its overall revenues into cesses, a special form of taxes that remain outside the GST pool and hence do not have to be shared with the states.
• Since 2014, cess revenues grew 21 per cent every year leading to a doubling in terms of its share of GDP.

Implications of these two problems for fiscal federalism

• The combined effect of these problems is that all states (collectively) get a lower share of overall revenues.
• Individual states face an ever-increasing disparity in the ratio of funds received from the Union as a proportion of taxes collected by the Union from that state.
• This is an affront to fiscal federalism and an assault on “cooperative federalism”.

Issue of ‘one state one vote’ system

• States that are more dependent on transfers from the Union want to maximise GST collections while states that are less dependent can afford to be more sensitive to citizens’ concerns.
• The case of taxes on Covid products is perhaps the starkest instance of such differences.
• Most large states are ready to forego this tax revenue for humanitarian considerations.
• But 19 states representing the remaining 30 per cent of the population seem keen to continue to levy GST on Covid products.
•  These are mostly smaller states.
• Given the smaller population of such states, the adverse impact of Covid taxes will be minimal for them.
• But they will reap the benefits of additional revenues from GST on Covid products levied on the much larger populations of the bigger states.

Conclusion

When direct tax policy decisions are legislated by Parliament, which has proportional representation from states according to their size of the population, indirect tax policy decisions should not be subject to one state one vote system.

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The article highlights the fundamental challenges the GST faces in the form of trust erosion and politicisation of decision making in GST Council.

Initial issues with GST

• The multiple rates structure, high tax slabs and the complexity of tax filings as the problems underpinning India’s GST.
• These were indeed the initial problems in the way GST was implemented, leading to some of its current woes.
• However, technical fixes such as simplification of GST rates and tax filing systems will not succeed in addressing the fundamental problems with GST.

Fundamental problems

1) Politics influence the decision of GST Council

• The 43rd meeting of the Goods and Services Tax (GST) Council which consists of 31 States and Union Territorie is to be held on May 28.
• Ideally, political affiliations should not matter in a Council set up to decide indirect taxes.
• The GST Council was mandated to meet at least once every quarter, but it had not met for two quarters, due to the pandemic.
• Several of the 14 members of the groups who belong to parties different from the party ruling in the Centre, requested the Finance Minister to convene the GST meeting to help them manage their finances.
• None of the 17 members of the ruling group deemed it necessary.
• Even the need for a meeting to determine tax revenues for States is evidently a political decision.

2) Lack of trust

• The GST Council is a compact of trust between the States and the Centre, set in the larger context of India’s polity.
• The tragedy of the GST Council is that it is afflicted with spite and forced to function under the prevailing cloud of politics.
• If the functioning of the GST Council is subject to the vagaries of elections and consequent vendetta politics, GST will continue to be just a caricature of its initial promise.

3) Uncertainty after the guarantee of 14% growth ends

• The States paid a huge price for GST in terms of loss of fiscal autonomy.
• GST has endured so far primarily because the States were guaranteed a 14% growth in their tax revenues every year.
• This minimised the risks of this new experiment for the States and compensated for their loss of fiscal sovereignty.
• This revenue guarantee ends in July 2022.
• This can lead to a crumbling of the precarious edifice on which GST stands today.

Consider the question “What are the challenges faced by the States in the GST regime? What would be the impact on States as a guarantee of 14% growth in tax revenue comes to an end in July 2022?” 

Conclusion

The end of India’s grand GST experiment seems inevitable unless there is a radical shift in the tone and tenor of India’s federal politics, backed by an extension of revenue guarantee for the States for another five years.

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The article deals with the issues of demand for the inclusion of fuel oils in the GST regime and its implications for the revenue of the states and the Centre.

How much tax we pay on petrol and diesel

• The Union and state levies put together account for roughly 55 per cent and 52 per cent of the retail price of petrol and diesel respectively.
• These work out to around 135 per cent and 116 per cent of the base prices of the two products respectively.
• The central levy on petrol and diesel works out to around 36 per cent of the retail price while the state component is around 20 per cent (diesel) to 28 per cent (petrol).
• Of the total central levies on petrol and diesel, Rs 1.40 per litre and Rs 1.80 per litre is the basic excise duty for the two fuels, and Rs 11 per litre and Rs 18 per litre is the special additional excise duty.
• Both these components form part of the divisible pool of taxes i.e. 42 per cent of which (approximately Rs 52,000 crore) goes to the states.
• The remaining portion of Rs 18 per litre in both cases is the Road and Infrastructure Cess and Rs 2.50 per litre and Rs 4 per litre is the Agriculture Infrastructure and Development Cess which are retained by the Centre.

How other countries tax fuel oils

• Being demerit goods, fuel oils and liquor are almost universally subject to a dual levy by countries that implement any kind of VAT or GST.
• The levy is a mix of GST at a fixed percentage of the price which qualifies for credit in the value chain and a fixed amount or percentage of the price which is not creditable and is thus outside GST.
• Punitive taxes of this order are levied primarily to discourage consumption of environmentally degrading fossil fuels and to garner revenues to fund infrastructure, while the creditable component enables offsetting of taxes on basically capital inputs.
• These products are subjected to a plethora of levies like VAT, excise duty, storage levies, security levies and environmental taxes in the EU and the total incidence of such taxes ranges from around 45 per cent to 60 per cent.
• The US is an exception in these matters since it imposes taxes at rates as low as around 15 per cent.

Including fuel oils in the GST regime

• the 122nd Constitution Amendment Bill in 2014 for GST adopted the delayed choice approach.
• Under the delayed-choice approach, petroleum products would be subjected to GST with effect from such date as the council may recommend.
• Accordingly, sections 9(2) and 5(2) of the CGST/SGST Act and the IGST Act respectively, explicitly provide for levy of GST on these products with effect from such date as the Council may recommend.
• Thus, bringing the aforesaid petro-products under GST is not within the reach of the central government alone.

How much will be the loss of revenue

• A 28 per cent levy of GST on the base price would fetch around Rs 5.40 per litre on petrol and around Rs 5.45 on diesel to the central and each of the state governments.
• Contrast the above with the current yield of Rs 32.90 per litre on petrol and Rs 31.80 per litre on diesel to the Centre alone and an average of around Rs 20 per litre and Rs 15 per litre on petrol and diesel, respectively, to each of the states.
• This, however, would bring down the prices of petrol and diesel to around Rs 55 per litre.
• This would translate into a revenue loss of around Rs 3 lakh crore on account of petrol and around Rs 1.1 lakh crore on account of diesel to the Centre and the states, at current volumes.

Consider the question “What are the various levies contributing to the prices of petrol and diesel in India? Examine the rationale for the heavy taxing of these products in India.”

Conclusion

Clearly, bringing petro-products under GST would not lower fuel oil prices by itself, unless the Union and the state governments are willing to take deep cuts in their revenues.

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The economic disruption due to pandemic has made the issue of GST compensation bone of contention between the Centre and the States. This article argues that it is the GST Council and not the Centre which is responsible to find ways to raise the revenue in such a situation.

GST revenue loss and role of the Centre

• Due to global pandemic, one significant area of loss of revenue to both the Centre and the states is GST.
• The states have the comfort of assured 14 per cent growth through the compensation mechanism.
• The Centre has no such guarantee.
• The Compensation Act mandates compensating the states for revenue loss on GST implementation from the Compensation Fund.

Role of GST Council

• The course of action to be adopted in the event of the amount in the Fund falling short of requirements was discussed at length in the GST Council.
• The late Arun Jaitley, then chairman, had, in the 8th meeting, assured that “in case Compensation Fund fell short of the compensation payable, the GST Council shall decide the mode of raising additional resources including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years”; the Council had agreed to this suggestion.
• Quite clearly,  it is the Council and not the Government of India that shall decide the mode of raising additional resources in the event of a shortfall and this is reflected in Section 10(1) of the Compensation Act.

Why it makes sense for the States to borrow

• It is argued that borrowings by the Centre or by the states make no difference in the context of fiscal discipline.
• The argument further adds that the Centre should borrow in view of its higher borrowing and debt-servicing capacity and its ability to borrow at lower rates.
• Article 292 (1) mandates that the Centre can borrow on the security of the Consolidated Fund of India (CFI).
• However, the idea of providing compensation to the states from the Consolidated Fund of India was not agreed to in the Council, it is difficult to agree with the suggestion that GoI borrows on the basis of the said CFI.
• Large borrowings by the Centre would push up the bond yield rates, pushing up bond yield of the states setting off a spiral leading to hike in the interest rates for businesses and individuals.
• The states’ borrowing would become costlier if the Centre were to borrow for this purpose.
• The borrowing capacity of the states, too, is not very inferior.
• The RBI study of state finances shows that the debt receipts of all the states as a percentage of GDP has hovered between 2.4 per cent and 3.6 per cent during the last four years.
• The states have on the average borrowed just about 1.25 per cent of the GSDP thus far.
• The states are consistently borrowing less than they can borrow (legally and financially).
• The cost of state borrowings for this purpose can be considerably lowered if arranged through a special window.
• The Centre has already breached the budgeted borrowing limits for the current year.
• Thus it makes sense for the states to borrow.

Borrowing options for the States

• There are two ways in which the States can borrow.
• 1) Borrowing the entire shortfall in the revenue.
• 2) Borrowing only the shortfall attributable to GST implementation with the remaining shortfall to be made good from the Cess Fund post the transition period.
• Certain conditionalities have been relaxed for option-1.
• However, borrowing the entire shortfall, as envisaged in option-1, will hurt both the markets and the private sector, pushing up the interest rate.
• The single window under option-1 being arranged by the Centre and the entire debt being serviced from future cess receipts will ensure that the cost remains close to the G-sec rate.
• Moreover, there will be no variation in the interest rate as between the states.

Conclusion

The states should come forward and work with the Centre in the true spirit of cooperative federalism that the Council has come to be known for these past few years.

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The GST compensation issue raises the need for reform in the system. The article discusses this issue and suggests reform.

Background

• Three years ago, the Centre and the States of the Union of India struck a grand bargain resulting in GST.
• The States gave up their right to collect sales tax and sundry taxes, and the Centre gave up excise and services tax. 

Issue of compensation

• Consent of the states 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 promised reimbursement was to fill the gap for an assured 14% year on year tax growth for five years.

Why is the Centre denying GST compensation

• As the economy battles a pandemic and recession, the tax collection has dropped significantly.
• At the same time, expenditure needs are sharply higher at the State level.
• Using an equivalent of the Force Majeure clause in commercial contracts, the Centre is abdicating its responsibility of making up for the shortfall in 14% growth in GST revenues to the states.

Why Central government is wrong in denying the compensation

•  1) The States do not have recourse to multiple options that the Centre has.[like sovereign bond or a loan against public sector unit shares from the Reserve Bank of India]
• 2) The Centre can get loans at lower rates of borrowing from the markets as compared to the States.
• 3) 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.
• 4) Fighting this recession through increased fiscal stimulus is basically the job of macroeconomic stabilisation, which is the Centre’s domain.
• 5) Using the alibi of the COVID-19 pandemic causes a serious dent in the trust built up between the Centre and States.
• It will weaken the foundation of cooperative federalism.

Reforms needed

• GST is a destination-based consumption tax, which must include all goods and services with very few exceptions.
• 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.
• Some extra elbow room for the States’ revenue autonomy could be allowed by States non VATable surcharges on a small list of “sin” goods.
• In the long term there are many changes in consumption patterns, production configurations and locations, which cannot be anticipated and hence a static concept of Revenue Neutral Rate cannot be reference.
• The commitment to a low and stable rate is a must.
• We must recognise the increasing importance of the third tier of government. 
• After 28 years of the 73rd and 74th Amendments, the local governments do not have the promised transfer of funds, functions and functionaries.
• 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.
• Fresh approach also calls for an overhaul of the interstate GST and the administration of the e-way bill.

Consider the question “Discuss the issue related to GST compensation to the States by the Central government. Suggest the measures changes in the GST regime to deal with flaws.”

Conclusion

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 co-operative federalism and also lead to enhanced economic growth. The current design and implementation has failed to deliver on that promise. A new grand bargain is needed.

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The article analyses the issue of GST compensation to states under GST regime for five years and how this has turned to be contentious issues after the economic disruption caused by Covid-19.

The basis for compensation

• Under Goods and Services Tax (GST) regime the Centre would make good the loss in the first five years if States faced revenue deficits after the GST’s introduction.
• States sacrificed their constitutionally granted powers of taxation in the national interest.

GST compensation cess

• To pay the compensation to states, GST compensation cess was introduced.
• When the GST compensation cess exceeded the amount that had to be paid to States, the Central government absorbed the surplus.
•  Now, the economy has slowed down dramatically and the resources raised are insufficient.
• The Centre is raising questions about whether it is legally accountable to pay compensation.
• The constitutional framework that ushered in the GST does not provide an escape clause for ‘Acts of God’.

Way forward

• As stated by the Secretary of the GST Council in the tenth meeting, the central government could raise resources by other means for compensation and this could then be recouped by continuing the cess beyond five years.
• Monetary measures are the monopoly of the central government.
• Even borrowing is more efficient and less expensive if it is undertaken by the Central government.
• As equal representatives of the citizens State governments expected the Centre to demonstrate empathy and provide them relief through the Consolidated Fund of India.

Conclusion

Central government should consider the legal provision in the GST regime and act in the spirit of cooperative federalism.

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