This piece is a part of TNM's reader-funded Cooperative Federalism Project. Indian residents can support the project here, and NRIs, please click here.
The Goods and Services Tax (GST) was hailed as a win for cooperative federalism — a rare instance when states gave up their powers of taxation, and the power to tax goods went from the state of origin to the destination state. There were initial cracks which were supposed to be smoothed over, but things came to a head after October 2020, when the Union government said that due to an ‘Act of God’, it would borrow the compensation amount and provide it as back-to-back loans to states.
States gave up their taxation powers because the GST assumed that between 2017 and 2022, state revenues would grow 14% year-on-year, with the base being the state’s revenues in the 2015-16 fiscal. And should there be a gap between the revenue states actually earned, the GST (Compensation to States) Act provided for this 14% growth projection to be financed by way of a compensation, and would be taken care of by a compensation cess levied on luxury and sin goods.
But then came an economic slowdown and the COVID-19 pandemic with its subsequent lockdown and unemployment and saw revenues of states plunge at a time when public spending on social welfare was more than necessary.
However, the woes of the GST started well before the pandemic. As activist and co-founder of collective ‘Shakti, Tara Krishnaswamy, says, the GST itself went against the concept of subsidiarity of governance, and that it fundamentally went against states’ rights.
“The fundamental premise of democracy is when states form a country, the individual unit should be able to govern themselves as self-sufficient as possible. The functions need to be devolved, and the ability to raise funds needs to be devolved. If states are responsible for 90% of services to citizens — water, electricity, roads, food supply, education, health —it needs to have a way to finance these things. Any other option is basically reducing states to teenagers — where they have aspirations for expenses but no way to generate funds,” she says.
She termed GST as a negative tax, where states aren’t able to service these needs despite generating enough money as it goes to the Union government. “If you take states like Karnataka, Tamil Nadu or Maharashtra, they are capable of generating taxes to finance their people’s needs,” she says.
“This has a real impact on people. This is not some abstract state rights or state autonomy,” she adds.
For states, the promised GST compensation stopped coming in and in August last year, Finance Minister Nirmala Sitharaman cited the pandemic to be an “Act of God” event leading to a contraction in the economy, ruling out the option of the Union government dipping into its coffers, or borrowing, resulting in a deadlock between the Union government and several states.
Nearly a year later, most states and the Union government are still at an impasse, with only more questions being raised about the GST and the GST Council.
The promises of GST from enhanced growth to a more harmonious national economy remain “mostly unrealised”, Tamil Nadu Finance Minister Palanivel Thiaga Rajan (PTR) said during his maiden speech at the GST Council meeting in June 2021.
At the centre of this debate lies the spirit of cooperative federalism and a deficit in trust between the Union and the states, with simmering issues coming to a head last year, when the Union government did not pay states the compensation for many months (it was supposed to be paid bi-monthly). Eventually, the Union government borrowed the shortfall from the RBI through a special borrowing window and gave it to states as back-to-back loans, which experts say the states had to accept, given the distressed situation they were in.
The compensation issue has dented the very spirit of cooperative federalism that GST was supposed to bring about. States will now be wary of entering into any agreement with the Union and this does not bode well for the future of federalism in the country, M Govinda Rao, a member of the Fourteenth Finance Commission and former director of the National Institute of Public Finance and Policy (NIPFP), tells TNM.
Rajeev Gowda, a former Member of Parliament and national spokesperson with the Congress, says that the Union government has behaved in a way that is exploitative. “It essentially betrays the original trust that every state had put in to make the GST mechanism work. There's a lot of repair work to be done to come back to some cohesive, consensual, trust-filled environment required for these sorts of engagements,” he says.
So what is the way forward to end the GST impasse?
In the current fiscal year, the Union government has estimated that the shortfall to states will be around Rs 2.59 lakh crore. Of this, Rs 1.59 lakh crore will be borrowed and passed onto states, similar to how it was done last year. Currently, a little over Rs 75,000 crore has been borrowed and passed onto states.
The revenue guarantee at a growth of 14% during the transition period, considered absurd even at the time, was what brought over many states to concede. But, as political economist Praveen Chakravarty told BloombergQuint, “Today, GST is being held together by a loose thread called revenue guarantee and that thread is about to snap in July 2022. So the choice is clear, if you want GST, you tighten that thread again.”
From Kerala and Tamil Nadu to West Bengal, Chhattisgarh, Punjab and Odisha, several states have called for an extension of the GST compensation period (which is set to end next year) and cesses, while still reeling from the effects of the pandemic, and preparing for a potential third wave.
Speaking to TNM, former Kerala Finance Minister Thomas Isaac has called for an administrative overhaul, which will take time, and hence the need to extend the compensation period for five years.
“States cannot afford to sit with the fall in the tax revenue. It doesn't come from the pocket of the Centre. It is from an additional cess,” he says, adding that the GST regime foreclosed all fiscal autonomy of states. Now, he says, Kerala wants to have much higher social expenditure, but cannot.
Kerala has been one of the loudest opponents to the GST regime, calling for significant changes. Current Kerala Finance Minister KN Balagopal has said in interviews that the GST regime is against cooperative federalism, and in 2015, when he was a Rajya Sabha member, opposed the legislation and stated it would impinge on the federal structure.
Former Finance Commission member Govinda Rao says that cooperation is only possible when states have political gains, and are currently disappointed with the reform because the pandemic has eroded revenues.
“More importantly, the GST Compensation saga has brought in a lot of distrust. This does not bode well for Centre-State cooperation in potentially beneficial areas in the future. The only solution is that the Centre should reach out to the states, try to make the tax decisions apolitical. Given the fact that GST is yet to stabilise, the compensation period needs to be increased though, it may be appropriate to revisit the formula,” he says.
Thomas Isaac says that there are immediate, pressing issues that need to be addressed with the GST regime which concerns all states.
Apart from the increase in compensation, Isaac demands that there be flexibility in the State Goods and Services Tax (SGST) rate. He says that states must be allowed to choose in a range of 1-2% deviation from the standard rate that is levied.
“For two years, Kerala has imposed a cess on SGST and nothing has happened. This must be allowed — it doesn't affect inter-state trade or CGST. This is a minimum that is required. You can’t straitjacket all state revenues to a national decision. There must be some fiscal autonomy,” he says.
In addition, the rates at which GST is levied is not revenue-neutral, he says, and must be revised upwards. Revenue neutral rate ( RNR) is used to estimate GST, and is a structure of different rates established in order to match the current revenue generation with revenue under GST. It pushes for certain products to be taxed higher than they are currently.
“You [the Union government] should shift some products to 28%. They were all having a burden of 40% tax pre-GST period. You pushed everything into 18%. I think luxury products must be moved into 28%. The rich who consume it can afford to give. India has one of the lowest tax to GDP ratios in the world. We must collect more taxes. There is no doubt regarding that — if you want to service your education, healthcare etc., you must do so,” he says.
Congress’ Rajeev Gowda says that as his party’s manifesto said before the 2019 elections, it too would move to a single, standard rate of tax on all goods and services, and a separate rate for luxuries. He added that the current system is too complicated, and the rate must be revenue-neutral.
Among all the issues with GST, several issues have been raised with respect to the GST Council itself.
PTR, in his maiden GST Council speech, said the Council was becoming, in some ways, “a mere ceremonial seal, a rubber-stamp authority.” He said that the real power had gone to “ad-hoc agencies, a feeble GST Secretariat, and the quasi-governmental GST Network.”
He also raised issues with the composition of the GST Council itself. The Council is an apex body that guides the implementation of the GST, and is headed by the Union Minister for Finance, and comprises Minister of State for Finance as well as finance ministers of the states. Matters in the GST Council have to be passed by consensus, but the Union government gets a de facto veto because it holds a third of the weighted vote. For any issue to be cleared in the Council, 75% of the vote is required. PTR called for the weightage of the votes of every state not to be the same, but weighted — and could adopt a formula similar to the constitution of the Rajya Sabha.
Govinda Rao too has called for changes such as a greater say for the states including the appointment of a vice-chairman preferably from an opposition ruled state, greater accommodation from the Union government to develop a harmonious relationship, improved capacity of the technical support with qualified tax economists and big data analysts recommending changes and their implications.
He added that one important thing states should stress in the GST Council is to activate the formal dispute resolution mechanism.
Under the GST, decisions made by the Council have to be implemented by amending the state’s laws, and the Union amending its laws as well. During an earlier interaction with TNM, TN Finance Minister PTR said that the system requires so much cooperation and coordination that unless it is fixed, there will be no ‘bright future’. He questioned what would happen if a state didn’t follow through and make the amendments.
The calls for a dispute resolution mechanism are not new. Punjab Finance Minister Manpreet Badal and Thomas Isaac have asked for a formal dispute resolution mechanism in the past as well.
Tara Krishnaswamy says that the centralised GST model is breaking the back of states, because the needs and aspirations of people are not being fulfilled. According to her, GST pushes people into poverty, because states are not able to finance fundamental human rights, civil liberties, livelihoods, food and education type issues.
Tara adds that while the complaints of businesses that the process was too onerous was valid and that business climate needs to be made more friendly, the primary goal of the government is to serve people.
“Simplifying and streamlining taxes is not the same as centralising the money. One is not the solution for the other. The price you pay is too high. In my opinion, the GST model itself is untenable and should go,” she says.
(1).png?w=640&auto=format%2Ccompress)