Tapping the GST growth opportunity

Recent buoyancy in GST collections should be used to usher in reforms in the tax system

The compensation regime for states under the Goods and Services Tax (GST) came to an end on June 30. The commitment made at the time of rolling out the GST in July 2017 was that compensation would be paid to the states for five years if the annual growth in their revenues was less than 14 per cent.

But many states, particularly those ruled by political parties other than the Bharatiya Janata Party, want the compensation regime to continue a little longer. Some states want this to continue for another five years. The demand was also raised a couple of days ago at the meeting of the governing council of the NITI Aayog, attended by the prime minister and state chief ministers.

How justified is this expectation?

The idea of compensating the states was mooted to provide necessary financial comfort to the states, who were apprehensive of a fall in their revenues. After all, the states were giving up their exclusive right to levy many taxes including the one on goods under the value-added tax (VAT) system that had been introduced from 2005. Hence, they wanted some sort of an assurance on a minimum annual rate of revenue growth in case their tax collections fell under the proposed GST.

Experts had suggested that compensation should kick in only when the annual growth was less than 11 per cent. However, in a grand bargain aimed at winning over the reluctant states, the then finance minister, Arun Jaitley, promised an annual revenue growth rate of 14 per cent, which meant that states showing actual collections growth below this level were to be compensated from revenues generated from a cess to be levied on some goods (the so-called demerit goods like tobacco, pan masala and expensive vehicles).

That system continued for five years. But soon after the GST roll-out, it became clear that the premise of a 14 per cent annual increase in revenues was an overestimation and would land the new tax system in trouble. In between, there was the Covid pandemic, which further depressed revenue collections, necessitating the Centre to borrow on behalf of the states and compensate them for the revenue that would have been due to them under the 14 per cent annual growth formula.

Illustration: Binay Sinha

Since the liability of servicing the loans of about Rs 2.6 trillion, borrowed on behalf of the states was on the Centre, the GST Council had decided to extend the levy of the cess for four more years, ending in March 2026. The idea was that the revenue from the cess would be used by the Centre to repay the loans. Meanwhile, many states began arguing that they too should get a share in the cess collections by way of compensation, which could be extended by at least two or three years, if not by another five years.

Two relevant questions arise. One, does the Centre need to keep the cess levied until as long as March 2026? The annual cess collection in 2021-22 was estimated at Rs 1.06 trillion. If the trend in the first four months of 2022-23 is any indication, the full year’s cess collection could be about Rs 1.2 trillion. Compensation dues of the states have been cleared till May 2022. So, cess collections could well be about Rs 4.5 trillion in the 45 months from July 2022 to March 2026. Would the Centre really need that much cess for repaying Rs 2.6 trillion plus interest?

Remember that the continuation of the cess beyond five years in the current form has affected the GST rate architecture. If the cess could be removed earlier than four years, the GST Council would enjoy a much-needed flexibility in restructuring the rates and align them to three broad slabs. The beneficial impact of an early reduction or withdrawal of the cess on inflation would also be significant. It is, therefore, necessary for the Centre and the states to examine closely how soon the enhanced cess collections in the coming months could help early repayment of the loans and end the levy.

The second question is even more important. The recent buoyancy in GST collections has offered an opportunity for the GST Council to justify the end of the compensation regime. In the last 12 months beginning July 2021, only two months have seen the annual growth in collections of state GST and the states’ share in integrated GST to be lower than 14 per cent. Even in those two months (December 2021 and July 2022), the growth rate has been between 11 and 13 per cent. In all other months, the range of increase in collections has been between 18 and 62 per cent. Such healthy growth rates are not just an outcome of a low base effect, but also represent a steady buoyancy in collections.

Given the recent months’ trend in overall GST collections and the expectation that the current year would see an average monthly collection of about Rs 1.5 trillion, it is likely that 2022-23 would see an above-14 per cent increase in collections of state GST and the states’ share in integrated GST. This will be an opportunity for the GST Council to introduce the much-delayed rate rationalisation, removal of exemptions and reduction in the number of rate slabs. With higher growth, it would also be easier to convince the states that the grand bargain was only meant for the first five years or the transition period.

Since that transition period is over, the Centre and the states must collaborate with each other at the GST Council to ensure improved compliance with the use of technology and enforcement of e-invoicing for all kinds of transactions. After tepid growth in GST collections in the first few years following its roll-out, 2021-22 saw for the first time a healthy increase in revenue mobilisation by about 30 per cent.

In the first four months of 2022-23, total GST collections have already crossed Rs 6 trillion, and the government’s internal estimate is that the full year’s growth could be 21 per cent over Rs 14.81 trillion in 2021-22. With buoyant revenues, this will be an opportunity for effecting the much-awaited reforms in the GST system. Rationalising rates and reducing bands can further sustain the revenue growth that is already in evidence. Wasting this opportunity would be a costly mistake.