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An unwelcome fallout of India’s economic slowdown has been a breakdown in communication between its Union government and states, especially around fiscal revenue- sharing. This friction is now extending itself between the states themselves, as evident from the recent Goods and Services Tax (GST) Council meeting, where the principle of ‘one state, one vote’ itself was questioned.

The biggest challenge facing our states is not the revenue-sharing formula, but the spectre of weak economic growth. Weak growth is not a zero-sum game between the Centre and Indian states. Slower growth hurts both equally. After June 2022, when the GST revenue growth guarantee of 14% ends, states cannot wish away the reality of a complex GST structure.

Challenging the principle of ‘one state, one vote’ goes against the grain of cooperative federalism among states themselves. While it is true that larger states do contribute more than they receive from the Centre in terms of tax revenues, this is central to the idea of redistribution for the country’s overall growth and development.

Even in its early days, the GST Council decided that ‘matsya nyaya’ (big fish eats small fish) was to be avoided, and hence the GST Council was formed in the true spirit of federalism with all states assured an equal voice. While we do not read too much into the latest comments, as they are in the nature of a non-sequitur, that line of argument also brings into question the labour and resource arbitrage that has prevailed across various regions for decades.

Indeed, a GST structure which has high implementation costs, along with slower activity levels, will hurt future tax collections. Rather than let the debate get diverted into one over the equality of the GST decision-making process, the collegium of state finance ministers needs to consider the best way to raise revenues organically once the safety net of assured revenue growth runs out.

On GST compensation to states, Vijay Kelkar told the Standing Committee on Finance (73rd report) that it would be small. It is time to take another look at the compensation rate, now that the original compensation period is ending next year. The terms of the original arrangement—by rate and duration— may be both infeasible and undesirable in the context of the future. A larger compensation rate can be made contingent on states making efforts to raise their own revenues through the recovery of economic user charges on water, power and property, with the latter being valued realistically and updated regularly over time.

Another issue is the natural tendency of the tax administration to want to minimize Type I error—no tax liability ever escapes being paid. This results in policy contortions and distortions in tax rates. Compliance costs rise, as does tax evasion. In the process, they stymie economic activity and defeat the goals of revenue growth obtained in a more organic manner. In this context, India’s urgent need to boost the economy presents an opportunity to bring about a convergence of GST rates. The original empowered committee of state finance ministers under Asim Kumar Dasgupta that later morphed into the GST Council had only proposed two rates: a low rate and a standard rate. A simpler and more reasonable GST rate structure should now be given an opportunity to succeed.

Further, carving out GST exceptions for the government itself only dilutes the framework itself. A recent notification (23/2021) to exempt government departments and local authorities from generating GST e-invoices may not be the right example to set. It may be better to demonstrate equal application of the law to everyone, especially considering that government transactions account for a small proportion of India’s total. More generally, exempting transactions from GST should be rare and exceptional. They distort the tax structure and add to costs—just as cesses, other exemptions and surcharges distort taxation, have cost implications, and should be done away with.

Eventually, we should look to expand the list of products and services that come within the GST net. Petroleum products are on top of that list. A small beginning could be made with aviation turbine fuel and natural gas. Its revenue implications will be minimal. Further, it would be advisable to launch a study to ascertain the reduction of cascading costs across entire value chains by the inclusion of diesel and petrol in GST, especially in the logistics/power sector, since an evidence-based argument will be essential to bring all fuel products within the tax’s ambit.

Given the current low-growth risk, the emphasis of states should be on boosting economic activity. Therefore, simplification of rules, rationalization of rate multiplicity and even a reduction in rates must be the preferred approaches. The introduction of GST may not have yet fully delivered the economic benefits envisaged because of the impact of an impaired financial system and later the covid pandemic. Current economic uncertainty provides an opportunity to take GST closer to its original vision, rather than reconsider it altogether.

V. Anantha Nageswaran, Rahul Bajoria and Najib Shah are, respectively, a member of the Economic Advisory Council to the Prime Minister, chief India economist at Barclays, and former chairman of the Central Board of Indirect Taxes and Customs. These are the authors’ personal views.

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