Context

After one and a half years of dispute, and with the economy showing signs of recovery, a path forward for the GST finally seems visible. This opportunity needs to be seized to strike the Centre-State bargain.

How GST performed so far

•  The contributors are many but the critical one has been simply a lack of revenues.
• Initially, the GST performed well, with collections soaring to Rs 11.8 lakh crore in the first full year of implementation in 2018-19.
• But in 2019-20, the growth rate decelerated sharply. And in 2020-21, collections actually fell.
• As future collections became uncertain, a gap opened up between the amount that the Centre felt it could afford to promise and the minimum that the states felt they needed and were entitled to.
• More recently, however, confidence in GST has improved.
• Collections have revived, averaging Rs 1.1 lakh crore in the first five months of the current fiscal year, exceeding even pre-pandemic levels.

What explains the weak revenue performance of the GST?

• Slowing economy: The GST’s past performance now seems much better than it once did.
• We now know that after 2018-19, nominal GDP growth slowed from 10.5 per cent in 2018-19 to 7.8 per cent the next year and -3 per cent in 2020-21.
• Effective rate cuts: The RBI has pointed out, the effective tax rate has fallen by nearly 3 percentage points because of rate cutting in 2019, in which both the Centre and states were complicit.
• Thus the weak revenue performance of the GST now seems attributable to wider economic difficulties and policy actions, rather than problems with the tax itself.

Necessary changes: Opportunity for striking bargain for Centre and States

1) Principle of compensation must be re-cast: Create revenue buffer

• As the GST was a new tax, so states were guaranteed against the teething troubles that would inevitably arise for the next five years.
• Five years on, this logic is less compelling.
• The GST as tax reform has reached maturity, well understood by producers, consumers, and tax officials.
• At the same time, the last few years have exposed the vulnerability of the states to shocks such as Covid-19 pandemic.
• Way forward: To prevent this situation from recurring, the authorities should create a revenue buffer that could be tapped in a time of need.
• In sum, there is a bargain waiting to be struck: The states give up their demand for an extension of the compensation mechanism, while the Centre offers a new counter-cyclical buffer.
• As the figure shows, in good economic times, GST revenues will be robust but it is against downturns that states need protection.
• The shift to revenue insurance, in turn, should allow the compensation cess to be abolished. 

2) The GST structure needs to be simplified and rationalised

• The GST structure needs to be simplified and rationalised, as recommended by the Fifteenth Finance Commission and the Revenue Neutral Rate report.
• New rate structure: A new structure should have one low rate (between 8 and 10 per cent), one standard rate (between 16 and 18 per cent) and one rate for all demerit goods.
• The single rate on demerit goods also requires eliminating the cesses with all their complexity.

3) The GST Council’s working needs changes

• Consensus-based decision making in GST Council can be sustained only if there is a shared sense of participatory and inclusive governance. 
• Nearly two decades ago, when the VAT was being introduced, Yashwant Sinha established a culture of consensual discussions on indirect taxes.
• He did this by requiring the Empowered Committee of State Finance Ministers to be headed by a finance minister from an Opposition-run state government.
• The spirit of this idea could be translated to the GST Council.

Consider the question “Inherent importance of GST and its significance for the cooperative federalism underline the necessity for the Centre and the States to strike the win-win bargain. In light of this, examine the issues with the GST and suggest the way forward to deal with these issuef.”

Conclusion

Cooperative federalism is not a gesture or one-off outcome. It is, above all, a disposition, resulting from quotidian democratic practice. By rehabilitating cooperative federalism’s finest achievement — the GST — the Centre and states can help restore India’s broader economic prospects.

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