Hot on the heels of the news that the Fifteenth Finance Commission may use the 2011—rather than 1971—census as the basis for a division of spoils between the centre and states, various southern political leaders from different parties have expressed their dissatisfaction with the current federal compact. To be sure, the move to use the 2011 census would significantly disadvantage the richer and less populous southern states at the expense of the poorer and more populous northern states. There is palpable anxiety among the southern states over their share of tax revenue allocated by the centre going forward. Indeed, the chief minister of Andhra Pradesh, Chandrababu Naidu, went so far as to withdraw his Telugu Desam Party from the ruling alliance over the issue of allocation of extra funds for the development of his newly formed state.
India also recently adopted the “one nation, one tax" — goods and services tax (GST)—regime. Recall, states in India, even before the GST, had no real powers of direct taxation to levy local income taxes on their residents. Now, with the GST, states have also lost their powers of levying local indirect taxes, essentially leaving them entirely dependent for all tax revenue on a transfer formula from the centre. With a system of taxation already heavily centralized, the GST has eliminated any possibility of any genuine state-specific taxation, to pursue development or other needs deemed appropriate by state leaders as opposed to those mandated by the centre.
This extreme fiscal centralization makes India unique amongst major federal democracies in the world. Amid such renewed tensions over fiscal federalism, an interesting question to ponder is: Had there been no GST regime, would these tensions have surfaced to the extent that they have now? Could Naidu possibly have resorted to other sources of revenue through state-specific taxes and not taken the extreme step of severing ties with the ruling dispensation over allocation of funds? How much of the recent tension between the more developed states and the centre is fuelled, in part, consciously or subconsciously, by the fact that states in India no longer have any direct fiscal powers?
Let us recall the context for this political tussle: that of large and widening inter-state inequality. Our earlier work, published in this newspaper and elsewhere, documents the skyrocketing trends in divergence of income per person as well as human development indicators between rich and poor states, which, we have argued, puts strain on the bonds of the Union. The life experiences of the average Tamilian and the average Bihari are as starkly different as comparing middle- income Asia with sub-Saharan Africa. In our work, we explicitly sound the clarion call for a “new idea" of India which takes federalism seriously.
Taking a cue from this churning contestation of a new India, some have been calling for a renewed fiscal federalism, and even a full-fledged decentralization of public finance, a call that we applaud. The stark question that arises is this: Can one argue strongly for decentralization while also simultaneously supporting India’s GST regime? The answer is: No.
Comparative political economy helps to make the point. For example, in Canada, where the GST is considered exemplary by many, GST was levied separately from provincial sales tax for many years until a hard-won compromise on revenue sharing allowed the two taxes to be harmonized. What is more, provinces levy income tax in addition to federal income tax, giving them considerable revenue capabilities. Likewise, municipalities levy property taxes to raise revenue, thus allowing a two-level decentralization from centre to province and to city.
The US system is similar, although even more decentralized: That country has never had a national value-added tax. States levy widely varying sales and income taxes, from high to zero, and, like in Canada, municipalities levy property taxes. Decentralization is hardwired into the US constitution, political ethos and history, and attempts to centralize are resisted fiercely by states and across the political spectrum.
What complicates this even further for India is the unique nature of its political diversity. Even today, nearly two-fifths of India’s national income and one-third of population are governed by regional political parties that have no electoral presence outside their specific states. More than 50 regional parties have as many legislators in state assemblies across India as do the two major national parties. These regional parties are incentivised to cater exclusively to voters in their specific state boundaries. This is the harsh reality of India’s electoral marketplace.
It will be a big challenge to balance the interests of a diverse set of states represented by a diverse set of political parties against the larger “national" interest, on a sustained basis.
The lesson for India is clear: to strengthen the Union, we need to federate further, rather than for the centre to continue to tighten its grip. The GST runs counter to this strand of thought. It is high time for a “new idea" of India, one rooted in the celebration of diversity, rather than the imposition of uniformity from the centre. One of India’s tallest statesmen, C. Rajagopalachari, warned in the early years of our republic: “You cannot achieve unity of this country by imposing uniformity".
Praveen Chakravarty and Vivek Dehejia are, respectively, chairman, data analytics department, Indian National Congress, and resident senior fellow, IDFC Institute, Mumbai. These are their personal views.
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