GST report card: In 5 years, states have given up more, gained less

No imposition of a tax was as widely heralded with euphoric glee as the Goods and Services Tax (GST) was, five years ago. Promises of milk and honey flowing freely with the advent of the new tax were made. The tax followed 17 years of tortuous negotiations with various stakeholders, most crucially the states of the Indian Union. 

Addressing Parliament on August 8, 2017, Prime Minister Narendra Modi invoked the name of the tallest Indian, Mahatma Gandhi, and the spirit of the Quit India Movement that he spearheaded in 1942, promising to liberate Indians forever from the scourge of “tax terrorism.” 

Unprecedented bonhomie in the political class was on display; indeed, it appeared that none among the political class was keen to sour the rare unanimity and euphoria that greeted the arrival of India’s most far-reaching tax reform since Independence. 

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The mood is very different five years on. There is widespread discontent and disenchantment with not just the way GST has been implemented but also in the way it has impacted various stakeholders. However, a fair audit of the GST would demand that it be assessed not just in terms of its impact but measured against the promises that were made in its name five years ago. 

Slowing growth, stagnant revenues 

An important caveat is necessary before undertaking an audit of GST. At the time it was implemented in 2017, the deadly effects of the demonetisation of November 2016 were already in play, which unleashed an unprecedented economic crisis.  Since then the Indian economy has been on a downward slope. 

The GDP data show that during the first four years of the Modi government, the economy grew at an average rate of 7.63 per cent per annum; in the next four years, it grew at less than half this pace, a mere 3.01 per cent. To judge the effectiveness of a tax at such a time, even if it was a much heralded one such as the GST, is hazardous to say the least. Given that tax revenues are inextricably connected to the performance of the economy, a proper evaluation of GST’s impact — good or bad — needs to await an economic recovery towards some semblance of normalcy. 

Nevertheless, it is possible to measure the performance of the GST regime against the promises that were made then. These were basically the following:

• That the GST promised a One Nation One Tax regime, promising to create a nationwide single market
• That GDP itself would magically increase by 1-2 per cent as a result of GST
• That the tax-GDP ratio, which was (and has been) in decline, would increase by 2 percentage points 
• That prices would decline by about 10 per cent as a result of GST
• That improved tax design would generate efficiencies, ensure greater compliance 

Much has been made about the multiplicity of GST rates, which is claimed to have made it more complex. Examples from other countries have been cited to make the point that the rate structures are too complicated. However, these comparisons are invalid for the simple reason that the Indian GST is unique because of the historical legacy of tax legislation in India. 

Unique regime, reflecting unique characteristics 

Comparisons with, say, Canada, Australia or the US, are irrelevant or invalid for the simple reason that the sub-national units in those countries have far greater access to other tax levers than Indian states did before the advent of GST. Moreover, only floor rates of taxes are prescribed in those jurisdictions, leaving much greater autonomy for these regional governments to fix the actual tax rates. 

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In India, the authority to levy taxes on final sales at the consuming end was, by deliberate constitutional design, vested with the states. The recent Supreme Court ruling has only reaffirmed this right of the states. Indeed, prior to GST, taxes on sales contributed almost two-thirds of the states’ own tax revenue. Thus the “grand bargain” that facilitated the advent of GST, which is reflected in the decision to compensate the states for losses for a period of five years, acknowledged the sacrifice that the states were required to make. 

Indeed, the record of deliberations during the long and tortuous process that preceded the entry into force of GST recognised that a uniform State GST (SGST) would rob the states of their right to tax whom and at what rates — the very test of sovereign powers. Thus, it was recognised that a plain GST system, one which did not take into account the Indian realities, would significantly impair states’ ability to raise resources. 

This is not insignificant: while states spend about three-fifths of the combined expenditures of the Indian Union, they have command over only two-fifth of the combined revenues.

Centre’s gains, states’ loss 

To recapitulate, while the Centre ceded its command over excise duties of various kinds and over service tax, bringing these within the ambit of the new GST, the states ceded far more by surrendering their most important tax lever, sales taxes. Two important aspects of the GST design have had a bearing on states’ revenues. 

First, the subsuming of excise duties within the new GST meant that the Centre was surrendering a tax that had a much narrower base, compared to states which had sacrificed sales taxes, which had a much wider tax base because they were levied on final consumption. Thus, by design, the GST demanded far more from the states than from the Centre. 

Speaking to The Federal, Prof KJ Joseph, Director, Gulati Institute of Finance and Taxation (GIFT), said: “GST would not have been possible if the states had not forgone a lot of their autonomy. They have lost 51.2 per cent of their revenues, while the Centre has sacrificed only about 28 per cent of its revenue base.” 

To put it differently, the states ceded much more of their ground as their contribution to GST, while the Centre gave up much less. The fact is that the states lost their autonomy over the most significant tax lever in their hands, while the Centre surrendered a very small portion of its powers of taxation. 

The second aspect of the GST design, which had a bearing on states’ revenues after the implementation of GST, was that the so-called Revenue Neutral Rate (RNR), the effective tax rate at which the states would not be worse off after GST, was decided at a rate lower than what official committees had prescribed in the run-up to GST. Moreover, it implied a uniform RNR applicable to all states, which is methodologically impossible to compute. To skew the balance even further away from the states, the decision to share equally in a 50:50 split the division between CGST and SGST was illogical, given the fact that the states were surrendering far more than the Centre. 

Compensation, the most contentious issue

The controversy over the continuation of the compensatory mechanism, whose legislative sanction lapsed on June 30, has to be seen in the context of GST’s design that imposed a very high sacrifice from the states. This is borne out by the states’ own experience of revenue mobilisation since the advent of GST. One of the key promises of GST was that it would ensure a buoyancy in tax revenues for the states, arresting a decline that was already underway in most states. 

A recent study conducted by Joseph and his colleague Anitha Kumary shows that the overall tax to Gross State Domestic Product (GSDP) for states has stagnated for a long period. The ratio has hovered around 6.6 per cent between 2013-14 and 2020-21. In fact, in a relatively more industrially advanced state like Gujarat, it has declined from 8.2 per cent to 5.8 per cent of GSDP in this period; in Karnataka, it has declined from 10.4 per cent to 6 per cent of GSDP; in Tamil Nadu; from 9.6 to 6.5 per cent of GSDP, and in Maharashtra, from 7.8 to 6.5 per cent of GSDP. 

“The tax-GDP ratio across states has been declining in the last decades and the simple truth is that GST has failed to arrest that,” said Joseph. “GST should have at the very least stemmed the declining tempo, but that has not happened.” He also cited various studies, including those conducted at GIFT, to make the point that prices of goods that attracted lower GST rates had not fallen, implying that only manufacturers and traders have benefited from the decline in rates. It is thus obvious that the promise that GST would result in prices coming down by as much as 10 per cent were fanciful fantasies not borne out by reality.  

The analysis of GST revenues by GIFT also reveals that while the Centre’s share of overall GST revenues has increased from 30.66 per cent in 2017-18 to 38.5 per cent,  an increase of 7.84 percentage points, the states’ share has only increased from 38.7 per cent to 44 per cent in this period — an increase of just over 5 percentage points. What this implies is that the states gained significantly less after surrendering significantly more, while the Centre gained disproportionately more after surrendering far less. In other words, the joint pool of GST revenues contains revenues that, properly speaking, belong to the states, not the Centre.

Lopsided GST Council 

Reducing the GST Council to merely a forum for fine-tuning rates has meant that the weighty issues that bedevil the GST system, including the contentious issue of compensation to states, have been relegated to the background. Thomas Isaac, former Kerala Finance Minister, has pointed out that the decision taken at the GST Council to raise GST rates on household items is “regressive.” Instead, he has called for an “increase (in) the rates on luxury goods and restore the initial 28% slab,” in order to raise resources. “GST,’ he said, “must comply with the canon of equity.” 

In any case, the structure of the Council is such that the Centre effectively has veto powers in it. Individual states would find it very difficult to gather the required strength to air their grievances or to seek redress in such a structure. The political clout enjoyed by the ruling party at the Centre and in most states also effectively shuts the room for dissent within a democratic space. 

Although the compensation cess that is levied on select “luxury” goods is to continue till 2026, the revenues from that would only go towards paying the back-to-back loans that the states had taken during the height of the pandemic. Joseph said the “uncertainty” over what form the compensation would take, if at all it even continues, can become desperate for the states. Perhaps that is the motive of the Modi government: push the states to the wall and force them to negotiate from a position of weakness. 

Perhaps the greatest challenge to GST will lie in how the tension between the Centre and the states is addressed. If the room for amicably addressing the gathering disenchantment is not provided, GST, at least in its current form, could face significant challenges as states lose even the limited room for manoeuvre that they have in the matter of taxation. That is the real challenge for the GST in the days ahead.

Indeed, a significant overhaul of the GST may be needed, in order to save it from the contradictions that undermine the constitutional safeguards of the core principles of federalism.

(The author, a senior journalist, is a member of the People’s Commission on Public Sector and Public Services)

(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the articles are of the author and do not necessarily reflect the views of The Federal)