After corporate tax cut, fiscal crisis reaches states' doorstep

States stand on the brink of a fiscal crisis as their financial situation worsens due to the combined impact of slowing revenue growth on the one hand, and the recently announced corporate tax cut on the other. Most of them might end up either cutting their spending or expanding their fiscal deficit, the impact of which will linger on for years to come, officials and experts have said. 

Tax revenue of 16 major states has contracted by 7 per cent in the first four months of the financial year (April-July), data accessed by Business Standard shows. Although five of them have growth in tax revenue, the quantum is small. 

While Andhra Pradesh, Rajasthan, Punjab, and Karnataka are relatively in a more precarious position, almost all of them are worried about the ways in which this situation can be faced, evident in the glaring gap in expected and actual revenue growth for most states. 

This is the very reason that N K Singh, chairman of the 15th Finance Commission (FC), urged states to increase buoyancy of their goods and services tax (GST) revenue. Buoyancy means the degree to which revenues rise faster than growth in the economy. 

The recent sentiment-boosting corporate tax cuts will cost the government Rs 1.45 trillion of gross tax revenue (GTR). Now, as states are a 42-per-cent-party to GTR according to the 14th FC formula, they will together bear nearly Rs 60,000 crore of this revenue loss. 

“Corporate tax is part of divisible pool and 42 per cent of the corporate giveaway rightfully belongs to the states. This corporate appeasement is at the expense of states’ fiscal space. The Centre will recoup its losses from one source or the other. But for states, it is a loss for good,” Kerala Finance Minister Thomas Isaac said. 

In this move, the Centre cut the base rates of corporate taxes, keeping the cess and surcharges intact. This is in line with the successive hikes in cess and surcharge on income taxes the Centre has been doing over the past few years. This cream never goes to states as cess and surcharge are not shared with states. 

But Centre, too, has its worries with a sunset year. States’ revenue shortfall due to abysmal growth in GST revenue this year — nearly 6 per cent over the previous year — will be compensated by the Centre to deliver a 14 per cent growth in GST revenues to states, till 2022. 

This is the reason state finance ministers are clearly lobbying against any kind of rate cuts in GST, looking at the broader horizon. 

“I don’t foresee any big-bang reduction in GST rates as we are already under revenue stress. Most of the states are dependent on compensation. So, until FC awards are declared, I don’t think that the Council is in a position to reduce rates,” Himanta Biswa Sarma, Assam finance minister, told Business Standard. 

The gap between expected revenue growth and actual growth observed in the first four months of FY20 is the reason experts think expenditure cuts are imminent this time. 

“Expenditure cuts are likely to be required to avoid substantial fiscal slippage,” said Aditi Nayar, principal economist at ICRA. 

“The actual capital outlay of the 17 states (analysed) was appreciably lower than revised estimates, partly reflecting expenditure curtailment necessitated by the lower-than-forecast revenue receipts. It is possible that the states resort to curtailing capex, to adhere to the fiscal deficit,” ICRA also said in a note published earlier this month. 

There have been multiple developments in public finance over the last few years that have put the financial position of states in peril, vis-a-vis the Centre. 

In the past two Union Budgets, including the one presented by Nirmala Sitharaman in July, the Union government hiked excise 

duty on petrol and diesel in the form of cess. The revenue to the tune of Rs 26,000 crore each year was entirely pocketed by the Union government, as cess revenue is not shared with states. 

This year, the government was successful to convince the Reserve Bank of India to pass on enhanced dividend to the former. 

The additional revenue over budgeted numbers will accrue only to the Union government, as non-tax revenue belongs uniquely to the Centre.