A case for reassigning GST to States

Context

• The article highlights the vertical fiscal imbalance (VFI) between the Union and State governments and need to restore fiscal balance by reassigning taxation powers to the states.

 

What is the need to balance Tax Revenue with States?

• The Union government is endowed with more tax powers than the States, while the States are assigned more expenditure responsibilities than the Union government.
• This gives rise to a vertical fiscal imbalance (VFI) between the Union and State governments that refers to the mismatch between the revenue-raising capacity and expenditure needs of the Centre and the States.
  • It equals one minus the ratio of the State’s own revenue to expenditure.
  • If this VFI ratio is zero, the States have enough own revenue to meet their own expenditure and there is no need for financial transfers.
  • If VFI ratio becomes more positive, it indicates that states own expenditure is exceeding its revenue owing to shrinking pool of taxes assigned or devolved to them.
• Hence, Article 280 of the Indian Constitution attempts to correct this VFI by establishing Finance Commission every five years to deal mainly with the asymmetry between expenditure responsibility (of states) and revenue-raising authority (Union or GST Council).
• However, this task to correct VFI remains unaccomplished by the Finance Commission.

 

The VFI Trend in India

• Increasing trend in VFI is being observed from the data for all the States over the periods of the last three Finance Commissions (2005-06 to 2020-21).
• For the latest period of 2015-16 to 2020-21, the ratio was 0.530, which means that only 47% of the States’ own expenditure was financed by their own revenue in that period.
• This was accompanied by four major changes as follows:
  • Expansion of divisible pool of taxes of the Union from two (income tax, corporation tax) to all (income tax, corporation tax, central GST and excise duties), thus enlarging the revenue base to be shared with the States.
  • Implementation of fiscal responsibility legislation to constrain the fiscal deficits of the States.
  • Dissolution of the Union Planning Commission, leading to the withdrawal of Plan grants.
  • Introduction of Goods and Services Tax (GST) in 2017.
• These changes hence have considerably altered the States’ revenue structure leaving them with little revenue autonomy and more dependent on the Union government.
  • For instance, the withdrawal of the Union government’s plan grants and loans to the States has affected the States’ combined budget.
  • Only 40% of the State’s expenditure was financed by their own revenue as VFI ratio increased for the same period to 0.594 from 0.530 between FY15 to FY20.

 

What is the Goods and Services Tax (GST)?

• It is a harmonised indirect tax on commodities that came into effect from 1 July 2017 through the implementation of the 101st Amendment to the Constitution of India.
• It is based on the principle of destination-based consumption taxation as against the present principle of origin-based taxation, i.e., will be collected at the state where the goods are sold instead of the manufacturing states.
• It is of various types as State Goods and Services Tax (SGST), Central Goods and Services Tax (CGST) and the Integrated Goods and Services Tax (IGST).
• It is divided into five different tax slabs for collection of tax - 0%, 5%, 12%, 18% and 28%.
• The GST Council, an apex committee to modify, reconcile or make recommendations to the Union and the States on GST, like the goods and services that may be subjected or exempted from GST, model GST laws, etc.
  • It also gives the Union government a veto to thrust its preferences on the States.

 

Rectifying the VFI by Reassigning Taxing Powers

• Bringing revenue from petroleum products under states: The CGST and the excise duty on petroleum products could be assigned to the States.
  • Presently, the Union government has exclusive power to levy excise duty on petroleum products, and the States have exclusive power to levy excise duty and sales tax on liquor.
• Quash Union control: GST shall continue as a tax determined by the GST Council. However, the veto power of the Union government should be removed by constitutional amendments to Article 279A.
  • This will enable the States to settle tax issues among themselves, with the Union government only facilitating the arrival of consensus among the States.
• Address horizontal fiscal inequality by equalisation transfers: The tax base of the GST, namely consumption, is not equally distributed among the States.
  • The unequal tax base with unequal expenditure requirement between the States creates horizontal fiscal imbalance among the States.
  • Thus, the Union government should allocate equalisation transfers (like grant-in -aid) to address the State’s fiscal capacity and expenditure needs and mitigating regional differences.
• Assigning entire commodity tax to the States: Commodity taxation should be moved to State List II of the Seventh Schedule of the Constitution.
  • The collection of commodity tax revenue by each State will then be a function of the size and structure of its economy and its efficiency in tax administration.

 

Optimistic Scenario by Addressing Imbalances in Devolution of Taxes

• Assigning excise duty on petroleum products to states will help the VFI come down to zero, owing to positive revenue effect.
  • A study revealed VFI at 0.005 (2015-16 to 2020-21), implying that all of the States' own expenditure can be covered by their own revenue resources.
  • It will increase the own tax revenue of the States and improve State’s accountability to their people on fiscal matters.
  • It will also hasten the process of integrating taxes on petroleum products into GST and remove the cascading effects of the current excise duty on petroleum products.
• As a result, there is no need to assign a share of Central taxes and aid grants to address VFI.
• By allocating all commodity tax revenue to states, the Union government will have little motivation to use non-divisible cess and surcharge collection because there will be no requirement for it to share tax earnings with all States.

 

Conclusion

• Reassigning taxing powers to the States is the ideal fiscal federalism in a market-driven economy.
• It will provide freedom for the States to chart their strategy of economic development, with the Union government playing the essential role of regulation of markets.

 

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Q1) What is GST Council?

GST Council is a constitutional body under Article 279A established for making recommendations to the Union and State Government on issues related to Goods and Service Tax such as good and services subjected or exempted from GST, model GST Laws, principles that govern Place of Supply, threshold limits etc.

 

Q2) What is fiscal federalism?

Fiscal federalism refers to division of responsibilities (including finances) among federal, state, and local governments to improve economic efficiency and achieve various public policy objectives.

 

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Source: A case for reassigning GST to States