The 15th Finance Commission has been given nearly a year more to come up with a formula to divide central taxes among states, though it is expected to submit an interim report by the end of this week that shall serve as a basis for the finance ministry to get cracking on the Union budget for 2020-21. The commission’s job has been complicated by the recent split of Jammu and Kashmir into two Union territories. The new deadline also gives the commission time to incorporate the effect of frequent revisions in India’s goods and services tax (GST) rates, an issue that its chairman, N.K. Singh, flagged earlier this month. States also want an extension of the period over which they are to be compensated—as promised by the Centre—for their revenue losses arising from GST adoption, and this could add to the complexity of the exercise. Singh has also called for easing the GST compliance burden to improve tax collection and for a rationalization of centrally-sponsored schemes in the absence of an oversight body like the Planning Commission. These are valid concerns that the GST Council and the Centre would do well to take up.
The tax devolution formula to be presented by the Finance Commission next October would be the first after GST kicked in. Collections of this tax have been trailing projections, with shortfalls attributed to the current economic slowdown as much as the hasty implementation of a tax regime riddled with imperfections. The new tax was supposed to boost the Indian economy’s growth and grant the Centre extra fiscal headroom. Instead, we’re in a slump and the gap between what the government earns and spends has widened. Despite commendable achievements in expanding the income tax base, the recently announced lowering of corporate tax will crimp the government’s direct tax intake. These dismal trends have aroused fears that the Centre might increase its reliance on special cesses and surcharges on taxes, an expedient way to shore up revenues that do not need to be shared with states, even though such an approach would go against the spirit of proposed taxation reforms. Direct taxes are crying out for simplification.
In all, the commission is saddled with an unenviable task. The demand of states for extended GST compensation does merit consideration, as does Singh’s suggestion that the Centre offload some of its welfare spending to the states: his team is expected to propose incentives for social welfare outcomes. While the Union government would want to set the template for such schemes, it would help if they are rationalized for efficacy. In general, the share of states in the divisible pool of taxes has been rising. The 14th Finance Commission recommended 42% of that pool for states, a generous hike from the 32% suggested by its predecessor. With central grants thrown in, states now walk away with most of what the Centre mops up. Arguments have been made that India needs big money for infrastructure and security, and so the Centre must keep more of the tax kitty. This, however, would dilute the principle of cooperative federalism that the commission is tasked with upholding. Singh’s critical challenge, though, would be to assess whether the economic slowdown is cyclical or structural, so that forecasts can be better made; also, whether Indian states have the resources they need.