People have been drawing myriad lessons from the Aam Aadmi Party’s (AAP’s) recent victory in the Delhi elections, which had its fair share of spectacle, cacophony and hate speech. These elections also partially echoed another grand experiment in federalism that is manifesting itself in different ways.

AAP leader Arvind Kejriwal’s steadfast refusal to address national issues—such as the Citizenship (Amendment) Act, or other thorny economic issues—and a laser-sharp focus on successful civic management helped the party reap dividends; it also highlighted gaps in the Bharatiya Janata Party’s (BJP’s) self-proclaimed governance record, especially on economic management.

This then makes one thing clear: Regional parties that invest time, capacity and resources in local issues are bound to harvest electoral bonuses. The operative word here is “invest", which implies availability of resources for development. This also places in sharp relief the Centre’s recent record of failing to transfer resources to the states, without which many of them will be unable to invest adequate funds. This failure to share revenues with the states now threatens overall development.

Kerala finance minister Thomas Isaac had recently said that non-BJP states were jointly formulating a strategy to respond to the Centre’s non-payment of compensation payable under the goods and services tax (GST) regime. In November 2019, five opposition-ruled states—West Bengal, Punjab, Kerala, Delhi and Rajasthan—had issued a joint statement highlighting their resource crunch caused by the Centre’s failure to pay.

A report in Business Standard on 11 February quoted finance ministry officials admitting that the compensation pool was facing a funds shortage, and that states may not get the amount initially promised to them. Compensation is an integral component of the GST architecture to recompense states for the abolition of local taxes like sales tax. This compensation, to be paid if and when states’ share in the GST pool falls below a certain run-rate, is financed from a cess levied on sales of “sin" goods such as tobacco products and luxury items like motor cars. The current economic slowdown has affected the consumption of all goods and services, including “sin" goods. This has compressed GST collections as well as cess generation.

According to the Budget 2020-21 document, the government expects to collect cess worth 98,327 crore till March 2020, which is 10% lower from its estimates in the beginning of the year. The government has so far disbursed 81,050 crore as compensation to states between April and September 2019. This means that if all goes well till March-end, the compensation fund will have slightly over 17,000 crore left in the kitty. Rating agency ICRA estimates that, given a pick-up in GST collections during the fourth quarter of 2019-20, the fund will have a final shortfall of 15,000-25,000 crore. Although the government has promised to clear all dues—this year’s as well as from previous years—the shortfall does impact the spending programmes of states.

More importantly, such shortfalls are bound to not only affect future investment by all states, including those run by the BJP, but can even exacerbate the ongoing economic slump. Numerous studies have shown that state expenditure, especially capital expenditure, is a major contributor to gross domestic product (GDP) growth.

It may be instructive here to draw parallels with the Congress regime under Indira Gandhi. There are multiple common strands linking then and now, but a notable one is the fraught nature of India’s fiscal federalism. Former prime minister Indira Gandhi’s rule was marked by a push to consolidate central authority, which was antithetical to the notion of federalism envisaged by the drafters of India’s Constitution. Intense power-play between a domineering Delhi and rebellious states often saw the Centre encroach into the domain of fiscal federalism, using the instrument of shared central taxes to reward and rebuke. Though the current BJP-led government is also somewhat prone to centralizing power, it is yet to openly use fiscal federalism as a stick; delaying payments could well change that equilibrium.

But, even before Gandhi’s time, a freight equalization scheme introduced during the 1950s stood out as one of the most iniquitous measures. Under it, the government gave a freight subsidy to industries that needed to transport inputs from production centres to final manufacturing sites. For example, a company using steel as a raw material on the west coast would be paid a subsidy to transport that steel from production centres in eastern India. But this was not applied to raw material from other regions, such as raw cotton or oilseeds from western India. This policy skew not only killed the engineering industry in Odisha, Bihar and West Bengal, but also discouraged future manufacturing investment, which seemed to gravitate toward west India. Former president Pranab Mukherjee recently blamed this policy for the area’s low industrialization despite being resource-rich.

Viewed charitably, this was perhaps the accidental outcome of a former finance minister’s misplaced zeal for equal development across the country. Similarly, it should be recognized that the unintended consequences of delaying the states’ share of GST compensation (and other transfers as well) could lead to a prolonged economic winter.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal

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