Electricity, petrol, diesel, specified petroleum products, natural gas, aviation turbine fuel and real estate are all worthy candidates for inclusion in GST architecture.
Last Friday, the Goods and Service Tax (GST) arrangement in India turned five. It was a significant landmark in the country’s fiscal history. Launched with considerable fanfare at the stroke of midnight on 1 July 2017, in a joint session of Parliament by then President Pranab Mukerjee, the new indirect taxation regime was born out of a fairy tale wedlock between the Centre and the existing 30 states and 7 union territories.
Almost 15 years of “courting” had preceded the announcement of the alliance, which was to herald a happier life ahead for all parties. Henceforth, the states were to give up almost all their sovereign powers of taxation exercised by way of levying value added taxes (the erstwhile sales tax), and excise duties on agricultural products, food, alcohol, and other defined products. They had also agreed to abolish the entry (octroi) taxes imposed by their municipal bodies. The Centre, in turn, had consented to share its exclusive power to tax services, and the levy of excise duties on manufactures and a variety of other goods. The consummation of the marriage after these vows was to result in a common and uniform indirect tax rate for the entire nation, with the cascading effect of “tax upon tax” disappearing and giving birth to input tax credits and their refunds. The other happy expected outcome was for aggregate annual GST revenue-receipts to experience robust growth when compared to the 17 separate central and state taxes and 13 cesses being subsumed under it.
THE EMERGING TRENDS
In assessing the efficacy of the new but relatively sophisticated arrangement, it is worth recalling the experience of past five years. Ardent proponents had projected that upon stabilisation, its adoption would lead to raising GDP growth by 2% annually. Unfortunately, despite the tax base expanding from 6.39 mn to 13.7 mn taxpayers, that did not materialise in any of the five years. The outbreak of the Covid-19 pandemic in early 2020, and the slowing down of global trade ever since Trump launched his tirade against WTO and China in particular in 2018, can only partially explain the non-fructification of the full benefits of the tax-rationalisation and simplification measures. Neither, have the overall tax collections risen for most of the period under review, with the GST to GDP ratio also remaining flat. Only in the past year, did this rise to 6.25, a level also attained in 2019. Prior to GST, in 2016, this figure was higher at 6.5.
A relevant question to ask is whether the new tax rates are too low in comparison to the taxes and cesses prior to their subsuming. As per RBI, the weighted average GST rate in September 2019 had declined to 11.6% from 14.4% in May 2017. The so called revenue neutral rate (RNR) worked out by Arvind Subramanian, the then chief economist of the Union Finance Ministry, was 15.5%. A deep dive reveals that apart from ab initio exempting 60% of items in CPI, fixing a low taxation rate of 5% for another 15% of items, and having 4 tax-slabs ranging from 5% to 28%, the GST Council has lowered the rates on over 200 products and services since 2018.
Political consideration—first, the 2019 general elections and then the annual exercise of Assembly polls—had prevented the rationalisation of the tax structure. The pandemic also contributed to the inertia. Another cause for not increasing the tax rates was the Centre’s preference for going in for a cess on GST especially on the so called “sin” goods already in the highest tax slab of 28%. Such revenue-yields are not required to be shared by the Centre with the states and were used to effect compensation as per the GST (Compensation to States) Act of 2017 enacted under the 101st constitutional amendment. The recent onset, and the persistence of the 96-month high inflation rate, is yet another reason for the Council not opting to extensively review the prevalent rates.
Yet another drawback in the GST architecture that has contributed to the lower than expected revenue is the exclusion of significant items from the purview of GST right from the beginning. Electricity, petrol, diesel, specified petroleum products, natural gas, aviation turbine fuel and real estate are all worthy candidates for inclusion. Perhaps, their being kept out of the regime was upon the insistence of the state governments to have some discretionary taxation powers. The subsequent levy of surcharge and cess on the applicable excise and other taxes on a few of these also came in handy for the Centre to raise resources exclusively for itself.
That said, their exclusion has adversely impacted the efficacy of the new tax regime. The energy costs for several goods and services constitute a high portion of total costs. Without the input credits, the overall prices of final products remain high and are a real contributor to the unduly high inflation currently being witnessed. Also, without the true costs of each significant input being determined, the inter se optimal substitution of raw materials and intermediates in the production process is eluded.
The issue of the statutory compensation to the states has invited comments. Assuring them a 14% annual increase in receipts over the audited figures of 2015-16 was indeed a generous, as well as shrewd move, by the then Finance Minister Arun Jaitley. It was liberal because only a handful of the 30 states and 7 union territories joining it had actually experienced such a robust growth in the years prior to GST. For a majority of them, it was too attractive an offer to be passed over. Surely it was a deft political move by the Centre in view of the states having to give up their already limited taxation powers. Their genuine concerns and feelings needed to be assuaged, particularly in light of the fact that they stand completely excluded from the levy of direct taxes and customs duties.
After frequent delays in effecting the assured compensation to cover the deficit in revenue-receipts, the Centre has now fully made good on the committed shortfalls. However, almost all states, including a majority of BJP ruled ones, are clamouring for an extension of the compensation scheme. Given its own precarious fiscal situation, the Union Government is understandably not up to accepting this demand. With this backdrop, the states could be expected to make use of the recent apex court judgement in the Mohit Mineral case, terming the GST Council’s decisions as advisory and non-binding. This opens up a window for the states to not fall in line with the proposals of the GST Council, especially those not unanimously passed. Theoretically, within certain parameters of restraint, states could have their individual slabs, specific rates, coverage etc. If this were to occur, the much lauded “one nation one tax” concept justifying a countrywide uniform GST regime would be wounded.
CONSTRUCTIVE FEDERALISM, THE ESSENCE OF GST
A pre-requisite for ushering in the GST regime five years ago was nurturing co-operative and constructive federalism, along with building mutual trust. After all, as described above, the states stood to lose their already limited, but much prised taxation powers. After their concurrence of the new taxation regime, the Centre needed to consistently work on mitigating their loss of power and enhance their ability to face unforeseen contingencies. The response, unfortunately, has been wanting. It was less than helpful in 2020-21, when it invoked the corporate contractual provision of force majeure or a God’s Act as a reason for backing out of fulfilling the constitutionally guaranteed compensation till mid 2022. Instead, it had proposed the states themselves raise the deficit amounts from the open market.
In particular, the fiscal and financial differences with the Centre and the dozen odd non NDA states have further widened. During the pandemic, when the needs of the state governments were higher and the revenue-receipts lower, such tensions only heightened. The Centre is yet to comply with the 14th Finance Commission norm for the sharing of direct taxes for the period 2016-21 viz 42% of the divisible pool. It continues to hover around 35% despite the Fifteenth Finance Commission endorsing it and GOI having expressed its willingness. Not unexpectedly, this has irked the provincial governments since the tax collections accruing to the Centre have consistently grown—both by way of its retentions and the non-shareable surcharges and cess.
Over the last two decades, the Union Government (no matter the ruling party in power) has shown scant urgency to address the genuine fiscal concerns of the states. This has been the case despite their aggregate expenditure accounting for as much as 60% of the overall government spending. Yet the transfers by way of devolved taxes and grants remain disproportionate, ranging at around one-third of direct taxes collected and one-half of indirect taxes subsumed under GST. Given their respective weights in overall revenue, this adds up to them getting about 40% of the revenues accruing to the Centre (excluding the income of surcharges and cess) to discharge their allocated responsibilities. With not much left in their domain to earn by way of taxes or fees, the states end up annually borrowing from the open market almost as much as the Centre. The consequential effects of their deficit financing upon the aggregate national liquidity, lending rates and levels of inflation are no less severe than of the union’s borrowings.
Despite the evident need, the frequency of institutionalised consultation between the Centre and the States has reduced in recent years. For years together, there has been no meeting of the Inter State Council set up statutorily to address contestations. The legal option of going to the apex court, with all the associated rancour and bitterness, remains the commonly followed way. It is time the Inter State Council were empowered to take action, suo moto as well as upon references made to it, and act within a prescribed time limit. Such a need is greater in fiscal and financial matters. This could also ensure that the Council becomes a standing body and convening its meetings would not be left to the whims of a few. Arguably, it is only then that we should see far reaching and progressive fiscal regimes like GST fully materialise and yield their potential benefits.
Dr Ajay Dua, a development economist by training, is a former Union Secretary, Commerce and Industry.
Part 2 of the article discussing the possible way forward will appear next Sunday.