Five years of GST: Taxing time for relations between Centre and states

Shrinking fiscal space has brought states on a collision course with the Centre

In August 2020, as the coronavirus pandemic ravaged states’ finances and their revenues dried up amid a huge shortfall in Goods and Services Tax (GST) compensation cess, at least 10 states – all ruled by parties other than the Bharatiya Janata Party (BJP) – rejected the Centre’s proposal that states borrow to meet the shortfall. This worsened the Centre-state tussle at the GST Council, with some states threatening to take the Centre to the Supreme Court if it reneged on its commitment of fully compensating for states’ GST revenue shortfall.

Since the rollout of GST five years ago as a grand bargain that would see states giving up their fiscal autonomy – the then finance minister Arun Jaitley called it “pooled sovereignty” — the country’s indirect tax system has come to a crossroads. The pandemic further strained states’ finances as the expenditure burden mounted. While the contentious issue of borrowing to meet the shortfall was resolved in states’ favour, a resolution on extending the compensation period beyond the initial five years, which ended on Thursday, could not be resolved at the recently concluded the GST Council meeting.

Trust deficit

At least 16 states debated an extension of the compensation cess regime at the latest GST Council meet – only three or four opposed it; the rest called for an extension. “There were broadly statements that compensation can be continued for at least a few years, if not five years. At this stage, I can just report that I have heard some states speak,” Union Finance Minister Nirmala Sitharaman said after the Council meeting, refusing to clear the air on the matter.

Tamil Nadu Finance Minister Palanivel Thiaga Rajan told a television channel that it is neither healthy nor in the spirit of cooperative federalism that the matter was only discussed in the Council without states getting clarity on the way forward. “Were the Union government to come out in the next three to six months and say it is going to reinstate some form of compensation for the next couple of years, how is that cooperative federalism? That means they get to decide all the important things and all complex things get to be decided by the Council,” he said.

Mathivanan N, principal partner at Lakshmikumaran & Sridharan, said one way of bridging the trust deficit is to confer more voting power to states in the Council. According to the Constitution, in case of voting, every decision of the GST Council has to be taken by a majority of not less than three-fourths of the votes. The Centre virtually holds a veto with its one-third weight of total votes.

“The Centre’s voting rights should be reduced to less than the veto power. This will ensure that even if a bunch of states are opposing a decision, the centre just can’t thrust it upon them,” Mathivanan said.

Fiscal autonomy

However, the more contentious issue for states is the loss of fiscal autonomy. With states giving up their power to tax most commodities, the poorer ones have become heavily dependent on their share of central taxes. Since the ‘own tax revenue’ of states as a proportion of total revenues has dwindled over the years, the skepticism over GST has only grown. While mineral rich states like Odisha and Jharkhand have lost out, the fiscal condition of debt-ridden Punjab has worsened. Producing states like Maharashtra and Tamil Nadu have also complained of revenue loss.

Former chief statistician of India Pronab Sen said under the current structure, states cannot devise a tax system that takes advantage of their production patterns. “The problem is most prominently visible in mineral producing states such as Odisha and Jharkhand. If minerals are charged at 5 per cent, which is what the state is getting, and the product made from that mineral is charged at 28 per cent, then the mineral producing state is getting very little and one which is processing gets a lot more,” he added.

An exception was made in the 32nd meeting of the GST Council by allowing Kerala to levy a flood cess only on intra-state supplies for two years to raise funds for reconstruction after the devastating floods during August 2018. Former Kerala finance minister Thomas Isaac has been advocating that this “limited autonomy” be made available to all states.

Sen said, technically, states should be free to levy whatever tax they like on the finished product consumed within their state, even under the GST regime. “Why should it be the case that a car in Delhi and a car in Kerala have the same GST rate? If Kerala doesn’t want its fellows to drive around in cars and wants the GST rate at 30-35 per cent, what’s the problem? The problem comes if the product is used as an input because then one can’t offset it,” he said.

After the recent Supreme Court judgment that reiterated the constitutional provision that states have equal power to legislate on GST, the clamour for more fiscal autonomy to states may only get louder.