Home / Opinion / Views /  ‘One nation, one tax’ wasn’t an ‘act of God’

The marriage between the Centre and states in India has never been a very happy one. Nonetheless, the couple never went for a divorce, and to the rest of the world it appeared a happy one. This has been made possible by mechanisms like the finance commission coupled with a compromising approach of states, which in turn was rewarded by various constitutional commitments by the Centre. The most recent compromise has been the implementation of the goods and services tax (GST). It was possible only after a decade-long negotiation wherein both surrendered many of the privileges of indirect taxation that they enjoyed. States, which together account for around 60% of the combined expenditure of the Centre and states, have been enticed to compromise with a constitutional guarantee of 14% growth in their tax revenue under the GST regime. Hence, had there been no GST Compensation Act, GST would not have been there for establishing the long cherished ‘One Nation, One Tax’ regime. The whole process has been touted as the success of cooperative federalism in the largest democracy of the world.

As the Indian economy turned from the fastest-growing economy to one with the lowest growth that led to the drying up of revenue, the Centre altered its position, seeking to get relieved from the burden of compensation. Describing the covid-induced slump as an ‘act of God’, it took the stance that states should borrow rather than demand compensation from it. States, however, have been under severe fiscal stress mainly on account of heavy expenditure incurred on saving lives and livelihoods during the pandemic. Obviously, states need the GST compensation. Much has been said on these lines.

What is missing, however, is a reflection on the context and rationale for GST compensation.

Tax revenue surrendered: Under the GST regime, tax revenue is shared equally between the Centre and states. Given the equality in revenue distribution, the question arises whether the cost of implementing GST has also been equally shared. The cost is viewed in terms of the pre-GST revenue surrendered by states and the Centre. A clear answer is provided by the Arvind Subramanian committee in its 2015 report Study on the Revenue Neutral Rate and Structure of Rates for the GST. The committee has shown that the revenue forgone by the Centre is 3.28 trillion whereas that by the states is 3.69 trillion. Our estimate revealed that this amounted to a surrender of 51.8% of states’ total tax revenue and 28.8% of the Centre’s gross tax revenue. While in absolute terms the difference is not substantial, in relative terms the surrender by states was almost twice that of the Centre. In such a context, GST compensation is the constitutionally paid price for the higher surrender that states have made.

Compromised revenue neutral rate: A pre-condition for establishing GST was to arrive at the revenue neutral tax rate such that the potential revenue loss to the Centre and states was minimized. A task force headed by Arbind Modi in 2009 recommended a central GST rate of 5% and state GST rate of 7%. The Arvind Subramanian committee recommended 8% and 9%, respectively, for the Centre and states. Thus, it is evident that for minimizing the revenue loss, the tax rate should have been higher in case of states as compared to the Centre. However, with the expectation of the constitutionally-guaranteed GST compensation, states agreed to reduce the tax rate such that today CGST is imposed at the same rate as SGST.

Forgone tax base: To a large extent, tax revenue depends on the tax base. Before the GST regime, tax revenue of the Centre from industrial output (excise duty) was limited to the point of manufacturing, indicating a very narrow tax base. On the other hand, states could levy tax on the entire supply chain up to the final consumption point. More importantly, the post-manufacturing stages in the value chain accounted for about 50% of the value addition.

With the introduction of GST, the Centre expanded its tax base at the cost of states and they have forgone substantial revenue for building the ‘one nation, one tax’ system. It is important to note that other than GST compensation, there are hardly any provisions in the GST Act to pay for sharing the tax base.

Forfeited cascading revenue: The cascading of tax is generally considered inimical to economic efficiency, but it served as an additional source of revenue mobilization by states during the pre-GST period. While the Centre has also been able to mobilize additional resources on account of tax cascading, given their higher tax base the benefits were proportionately higher for states. Therefore, with GST addressing the issue of cascading taxes, states lost more than the Centre. It was with the promise of GST compensation that states forewent this revenue source.

Conceded tax rate: Apart from the tax base, the tax revenue is governed by the tax rate. During the pre-GST period, most goods attracted a tax rate of 14.5% by states. With the introduction of GST, the 14.5% category goods have been brought under the 12% or 18% category wherein states’ share being 6% or 9%, respectively. Only a few goods were brought under the category of 28% where in the share of states is 14%. Thus, with GST, states lost 8.5% for those goods brought under 12% and 5.5% on those taxed at 18%. This loss has also been expected to be covered under the GST Compensation

On the whole, it is high time to recognize that the GST Compensation Act is premised on the explicit recognition of the unconditional surrender that states have made towards forming a one common market with one tax—a prerequisite for any globally-competitive economy. Hence, it is fair to say that in the absence of GST compensation, the regime itself would not have been born. This being the case, one fails to understand the reason as to how it could continue without the compensation, even after five years. In the interest of sustaining cooperative federalism, the compensation cannot be limited to a five-year period. As long as there is GST, there should be GST compensation for states.

These are the authors’ personal views

K.J. Joseph and N. Ramalingam are, respectively, director and associate professor at Gulati Institute of Finance and Taxation

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