A case for greater GST autonomy to states

The Supreme Court’s order of May 19, 2022, on GST may have far-reaching consequences for cooperative federalism. Among others, the court ruled, “Parliament and the state legislatures possess simultaneous power to legislate on GST,” the GST Council’s recommendations “are not binding on the union and states”, such recommendations “only have a persuasive value” and the objective of the GST is “to foster cooperative federalism and harmony between the constituent units”.

This is bound to revive the now-forgotten debate. When the first GST Bill was introduced in 2011, during the previous UPA regime, many state governments, and tax and policy experts were worried that by giving up their rights to indirect taxes (which the adoption of GST entailed) states would be compromising on their fiscal autonomy. There are several reasons now (GST was rolled out in 2017) why that debate would revive, but first some clarity on the apex court order.

The order is very much in line with the 2016 constitutional amendment (101st) that paved the way for the GST regime. The amendment clearly spelt out that the GST Council “shall make recommendations to the Union and States”. Through this amendment, as the court order points out, the GST Council was put under Article 279A of the Constitution, instead of Article 297B as envisaged earlier, to allay fears of states about compromising their fiscal autonomy.

There is yet another provision in the 2016 constitutional amendment the spectre of which now looms larger. Section 279A(4e) of the 2016 amendment says the GST Council is empowered to recommend “the rates including floor rates with bands of goods and services tax”.

There are two elements to this. The GST Council may recommend: (i) “floor rates” and (ii) “with bands” or ranges. That is, the council is empowered to recommend not only specific floor rates but also a “band” or range for each in which the rates would operate. In simple terms, this means if the council recommends a floor rate of 28% for luxury goods with a “band” of, say, 1-2%, the Centre and states would have the discretion to set a rate which is 1-2% more or less of 28%.

This “band” of rates is inbuilt into the current “harmonised” GST structure/regime – that is, the same laws (for CGST, SGST and IGST), rules, processes etc. which govern the GST.

Thus, the apex court order isn’t changing anything or threaten to derail or destabilise the GST regime but merely reiterates what is already provided in the statute.

Centralised fiscal federalism of GST

Though the GST was conceived as a manifestation of the cooperative federalism between the Centre and states, it has caused many heartburns in states over the years for several reasons.

Firstly, states sacrificed the fiscal space more. The 15th Finance Commission estimates show the subsumed indirect taxes (in the GST in 2017) accounted for 35% of the gross tax revenue of the Centre but 44% of the “own tax revenue” of states. States, thus, lost more in terms of rights over tax resources.

In FY19, the 15th Finance Commission found, the state GST (SGST) component of states’ “own tax revenue” was 41.5% and non-GST taxes constituted the rest 58.5% – tax revenues from sales tax on petroleum and alcohol (24.3% of own tax revenue), state excise (12.3%), stamp duties (10.4%), vehicle tax (5.7%), electricity duty (3.5%) and others (2.3%).

It also found shortfalls in SGST collections (vis-à-vis the assured path), which was “about ₹7.1 lakh crore until June 2022”. This shortfall is for the entire period of July 2017 to June 2022. The anticipation of this shortfall was the reason behind instituting the GST Compensation and GST Cess (to provide for the GST Compensation) in the Goods and Services Tax (Compensation to States) Act of 2017. Both the compensation and cess were to be valid for a period of five years from July 2017 to June 2022.

The 15th Finance Commission had estimated that the GST cess would be able to generate only ₹2.25 lakh crore until June 30, 2022 – while the shortfall in SGST would be ₹7.01 lakh crore. Hence, it talked about extending the cess until June 2026 to generate the entire shortfall.

It is in keeping with this the Centre has amended the GST law of 2017 to extend the cess till June 2026. But no GST compensation would be paid after June 30, 2022. This is the second cause of heartburn for states and may spark a new conflict because the shortfall in SGST would continue beyond June 30, 2022, too. Who will compensate states for the shortfall? How will states be compensated? There is no clarity on either.

After the Centre decided to discontinue paying GST compensation in November 2019 due to fiscal constraints and started borrowing money from the RBI in lieu of it. It has already borrowed ₹1.59 lakh crore in FY21 and Rs 1.1 lakh crore in FY22. The GST cess to be collected until 2026 will go to repay these loans.

The current fiscal of FY23 would test states for their fiscal resources and the spirit of cooperative federalism. Having lost most of their powers to collect indirect tax – except on oil and liquor – their dependence on tax devolution from the Centre would be heightened.

The extent of SGST shortfall is not known. The 15th Finance Commission expressed its inability to estimate the shortfall during its award period of 2021-26 because it said “the initial twenty-seven months of the award period are covered by the GST compensation scheme and the last thirty-three months are not”.

Third, the Centre has been sharing much less tax collections than the Finance Commission awards. As against the award of 42% to states during the 14th Finance Commission period of FY15-FY20, the actual tax devolution was 33.6%. The 15th Finance Commission awarded 41% share to states, but the actual devolution was 29.5% for FY21(RE) and FY22(BE). The tax devolution has grown over the years but the shortfall in devolution has also grown. The shortfall in devolution was 4.1 percentage points during the previous UPA years of FY05-FY14. It went up to 8.4 percentage points in the 14th Finance Commission period of FY15-FY20 and then climbed to 11.5 percentage points in the 15th Finance Commission period of FY21 and FY22.

Fourth, the Centre has increased surcharge and cess on a wide range of items post-2014, which are not part of the divisible tax pool the collection of which is shared with states. Analysis of data shows that surcharge and cess constituted 9% of the Centre’s total gross revenue receipt during FY13-FY15, which shot up to 17% in FY20 and then to 18% in FY21.

This means, the Centre is using its power to collect a surcharge and cess, which are meant for its exclusive use, depriving states of their fair share.

Fifth, the Centre is further limiting the fiscal space for states.

In an unprecedented move, amidst the pandemic disruptions, it allowed states to borrow an additional 1% of the GSDP in October 2020 subject to four reforms – (i) ‘one nation one ration’ system (ii) improvement in ease of doing business (iii) power sector reforms and (iv) urban local body reforms.

This had never happened “in the history of independent India”, pointed out Govind Rao, a tax expert and member of the 14th Finance Commission.

Case for more fiscal space for states

The case for higher fiscal autonomy and independence of states can’t be overstated or need elaboration. Many states have larger geographical areas and populations than most European countries. They have the constitutional rights to fiscal autonomy too, as the latest Supreme Court order makes it very clear.

The good part of the Supreme Court order of May 2022 is that states can have greater fiscal autonomy without derailing or disrupting the existing GST structure. That can be done by using the new Article 279A(4e) to provide a “band” of rates.

Allowing a “band” for tax rates, this would create its own distortions in the system. The Comptroller and Auditor General of India (CAG) had found this to be so in the case VAT – in which case states were different rates within a narrow band of 1-1.5 percentage points. Further, deviations from the GST rates may cause tax leakages and increase the burden of compliance and administration.

But there are reasons to be optimistic that in the case of GST, these distortions and leakages can be better managed.

For one, the GST’s nine tax slabs can be reduced to 1-3 rates as was originally conceived. For another, the GST Council has been in place for five years, regularly meeting and taking a call on rates and sorting out other complications. A new IT infrastructure and tax administration have also been put in place. The Centre and states have learnt to cooperate in tax matters more than ever in the past. All these factors would come handy if the “band” for tax rates is allowed – within the existing “harmonised” GST structure.

States also deserve greater fiscal space for several other reasons to take the risk that a discretionary GST regime (band of tax) may entail.

For example, budget documents and Economic Survey reports show states are far more fiscally responsible than the Centre. During 11 years between FY12 and FY22, the annual average fiscal deficit for the Centre is 4.9% of the GDP, while for states, it is much less at 2.7% of the GDP.

At the same time, states have consistently outperformed the Centre in capital expenditure. The Centre’s capex averaged 1.7% of the GDP as compared to states’ 3% of the GDP during the same period (FY12 to FY22).

Not to forget that states have a much lower tax base compared to the Centre.

Official statistics show the Centre’s tax receipts averaged 10.3% of the GDP during FY12-FY22, while states’ “own tax revenue” amounted to only 6.4% of the GDP.

Shouldn’t states then be given more fiscal space through the GST?

Cooperative federalism doesn’t mean dismantling the “union of states” that India constitutionally is and replacing it with an overly centralised fiscal regime that may better be described as a “unitary state”.