The future of GST hangs in the balance

The Centre is best positioned to raise additional resources to bridge the GST compensation gap

“The credibility of the GST Council and the larger idea of cooperative federalism can still be salvaged if the Centre can shed its cussedness.“ Union Finance Minister Nirmala Sitharaman chairs the 41st GST Council meeting via video conferencing in New Delhi in August 2020. PTI

October 05 2020

Today is the crucial meeting of the Goods and Services Tax (GST) Council. It may not be an exaggeration to claim that today’s meeting could mark a milestone in the history of India’s fiscal federalism and shape the future of Centre-State relations.

In 2017, the Centre made a promise to the States that a certain minimum amount of GST revenues will be guaranteed to every State for every year until 2022. GST was born in the cradle of this promise and hailed as a harbinger of ‘cooperative federalism’. Now, there is not enough money in the GST kitty for the Centre to honour this obligation. The Centre has therefore proposed that the States should borrow money to bridge this gap and that it will act as a guarantor to facilitate this borrowing. Many States have accepted this proposal while many others have rejected it and implored the Centre to borrow. There is a bitter stand-off between the Centre and these protesting States.

Widening trust deficit

This is further complicated by the recent revelation of the Comptroller and Auditor General, and explained by Professor Govinda Rao in The Hindu, that in the last few years, the Centre deliberately mis-allocated nearly ₹3 lakh crorecollected through various cesses, to reduce the States’ share of tax revenues. The Centre’s dishonesty has eroded its credibility with the States and widened the trust deficit. Amidst this background, the GST compensation issue could be put to vote in the GST Council meeting today.

The GST Council has 31 States and Union Territories represented. The Council was set up in 2017 as a new financial institution with the enormous economic responsibility of directing policy for half of all tax revenues of the country. Sadly, this vital institution, like many others, has dwindled rapidly into yet another avenue for political power play.

Twenty members of the GST Council that have agreed to the Centre’s proposal are governed by the Bharatiya Janata Party (BJP) or a BJP alliance. The 11 States that have opposed the Centre’s plan are all governed by the Opposition. The 11 opposing States account for a greater share of overall GST revenues than the 20 supporting States. But it does not matter since every State, large or small, has equal weight in the GST Council. Twelve votes can veto a proposal in the GST council.

The Centre has reiterated its commitment to fulfil the GST compensation obligation to the States. So, only the modus operandi of raising funds to fulfil this obligation is to be decided. This is primarily an economic issue and should be settled based on what makes the most economic sense for each State and for the nation overall.

Each State’s economic realities are distinct. Just four States — Maharashtra, Gujarat, Tamil Nadu and Karnataka — account for nearly as much GST tax revenues as the remaining 27 States and Union Territories combined. But Gujarat and Karnataka support the Centre’s proposal while Maharashtra and Tamil Nadu have opposed it. GST compensation constitutes a significant share of the revenues of Punjab and Himachal Pradesh, yet Himachal Pradesh supports the Centre’s plan while Punjab is against it. Rajasthan and Haryana have similar sized fiscal deficits. Rajasthan is understandably apprehensive, but Haryana seems ready to indulge in more borrowing.

Naïve and clichéd as it may sound, a State’s decision to borrow or not should be based on its fiscal situation, not its political affiliation. State fiscal policies are complex matters and cannot be decided through a ‘high command whip’. The GST compensation imbroglio has exposed the shallow rhetoric of ‘cooperative federalism’ and exacerbated the politicisation of the GST Council.

Alternative revenue sources

Economic logic suggests that the Centre, and not the States, is best positioned to raise additional resources to bridge the GST compensation gap. State governments don’t have the powers to levy direct taxes or indirect taxes to earn additional revenues. A State’s finances are not in the hands of the State government any more.

But the Centre has multiple alternative revenue streams. It is true that COVID-19 has ravaged the economy and strained government finances. But even in this severe economic slowdown, the Centre can find some new and creative options for tax revenues that are not available to the States.

Purely for illustrative purposes, one such revenue opportunity can be through increased taxation of capital market transactions. Between April and June, when economic activity in the nation had come to a complete standstill, India’s stock markets experienced its highest activity levels in its history, with a 75% increase in transactions vis-a-vis last year. The stock market rose 30% in this period and a minority few profited handsomely. In all likelihood, this buoyant stock market activity did not create one extra job in the real economy. The Centre can levy a higher tax on such speculative stock market trading to earn additional revenues during these difficult times, which will also not hurt the economy like an increase in GST rates or cess will do.

A five-fold increase in the securities transaction tax from its current minuscule levels of 0.025% can potentially generate an additional ₹50,000 crore of revenue for the Centre, which can be very handy in these times. Contrary to belief and fearmongering by stock market participants, 15 years of data show there is no evidence that, in India, raising securities transaction taxes adversely impacts stock market activity or the overall economy.

The larger point is that such options for new revenue generation are not available for the States. In these dire economic conditions, the Centre has many more avenues to raise additional resources than the States. A combination of additional revenues and borrowing by the Centre can help resolve the GST compensation issue amicably.

There is fear that the international ratings agencies may downgrade India’s rating to “junk” status if the Centre’s borrowings rise exorbitantly. It is understandable that no finance minister or bureaucrat wants the badge of a downgrade. But it is inane to believe that just offloading the borrowing to States can fool the ratings agencies.

The economic argument is crystal clear that it is more prudent for the Centre to use its much greater ammunition to raise additional tax revenues and/or to borrow to keep its GST promise. It makes no economic sense for the States, regardless of which party is in power, to increase their borrowing at the behest of the Centre. States will be forced to borrow anyway for their own expenditure. The credibility of the GST Council and the larger idea of cooperative federalism can still be salvaged if, in today’s meeting, the Centre can shed its cussedness and end this impasse by committing to raise resources to plug the GST compensation gap.

Praveen Chakravarty is a political economist and a senior office-bearer of the Congress party

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