Home / Opinion / Views /  Variations in the GST experience of states may have a big message

One of the most significant economic reforms undertaken since Indian Independence was the 2017 implementation of the goods and service tax (GST), which subsumed state and central indirect taxes to create a simpler national tax. The move was an attempt at economic integration of the country by removing different taxation regimes, easing the mobility of goods and services, and removing state-level entry barriers with an aim to improve trade as well as aid the overall economy. Indeed, since the introduction of the GST, there has been an increase in indirect tax collections and also a sustained improvement in compliance. It is important to view GST revenues as an outcome of both compliance and growth. The average tax rate is also an important determinant. The key point is that since GST’s launch, there has been an attempt by the GST Council to rationalize rates, and the outcome of this has been a reduction in the effective weighted average GST rate from 14.4% in 2017 to 11.6%.

The enhanced buoyancy has been thanks to improved compliance, both due to a simplification of the taxation system as well as rationalization of rates. However, these improvements do not reveal the extent of differences in the experience of various states with respect to the GST. For instance, only a few states have managed to achieve the desired GST revenue targets. Therefore, the compensation cess had to be used extensively to compensate states during the first two years of its implementation. A state-wise assessment is important, as it illustrates the point that despite an overall increase in the compensation cess amount, the number of states in need of its proceeds went down in 2018-19. This year’s covid pandemic has strained the fiscal positions of both the central and state governments. This was the backdrop against which the issue of GST compensation emerged as a conflict between the Centre and some states, though it has largely been resolved in the spirit of cooperative federalism.

There is, however, a larger issue that needs to be discussed. This relates to differences in the abilities of states to plug leakages and improve compliance. More importantly, since GST revenues depend on the extent of economic activity, states that are able to do better in promoting commerce would succeed in meeting their targets. Thus, the fundamental challenge that emerges is of creating incentives for states to undertake deep systemic reforms to boost their economic growth over the next few years. Doing so would surely reduce the need for any compensation, and public money could be better utilized elsewhere.

It is encouraging to observe how some of India’s north-eastern states have managed to register higher GST collections compared to most other states. A part of this could be because of the base effect, given that their intake was relatively low to begin with. However, we are comparing revenues in 2019 with those in 2018, both of which were under the GST regime. The strong revenue growth witnessed by the north-eastern states augers well for their development as they catch up with other states. Their performance could also be on account of the current central administration’s focus on developing the region for its integration with India’s economic growth story.

It should be noted that GST is a destination-based tax, levied at the point of consumption rather than production. This is important here, as economic activity rarely takes place in isolation. Production is preceded by the consumption of inputs, with the GST essentially a charge on value addition, and both must reinforce each other for collections to rise. Some industrial states have witnessed a modest increase in collections, and this could be a result of leakages being plugged by them. This trend suggests a need for larger states to examine the issue of GST compliance, while also looking at ways to increase the level of economic activity within their borders. Other state governments must examine the local factors that may have dampened the growth of tax revenues.

The long-term solution to the compensation issue lies in fostering greater economic growth, and this is something that needs to be squarely recognized by states and their finance ministers. The GST Council must also routinely relook some of the tax changes it proposes and put them to test, and not with their effect on revenues in mind, but with their impact on economic growth in the medium- to long-term under examination. This will be critical for a long-term improvement in the finances of both states and the Centre.

Interestingly, there has been an attempt by the central government to put economic incentives in place for states to undertake reforms. For instance, a part of the relaxation in borrowings under the Atmanirbhar Bharat plan was linked to state-level reforms in areas like agriculture, land and labour. The same could be replicated by the GST Council in incentivizing states to take a comprehensive economic perspective while formulating policies. At the same time, attention must be drawn to the economic impact of changes to the GST structure, as undertaken by the council from time to time.

Vivek Singh & Karan Bhasin are, respectively, additional private secretary to the finance minister and an independent economist.

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