GST Compensation: Are States Suffering Because They Got ‘Greedy’?

States refused to face reality, that India’s economic slowdown would cause tax revenues to stagnate.

Image used for representational purposes.

(Photo: iStock / Altered by The Quint)

Right from the time when India was born as an independent nation, it has struggled to resolve two contrary imperatives:

• The first was the need to establish a strong united country.
• The second was to fulfil the aspirations of the provinces that were bound together by linguistic and cultural ties. Taxation became a core issue in the debates over how to create a federal structure without weakening the Centre.

The argument for federalism was best delineated by Kasturirangan Santhanam, a Gandhian from Tamil Nadu, who was to become Railway Minister in the Nehru Cabinet. Speaking during the Constituent Assembly Debates, just five days after Independence, Santhanam said if the powers to tax are concentrated with the central government, “the provinces will be beggars at the door of the Centre.”

Taxation: Santhanam’s Warning About Excessive Centralisation

Santhanam pointed to the American example, where states could “levy all kinds of taxes.” State governments could “go to the people and say “we have got powers of taxation; pay the taxes and we will give you entertainments, circuses, and whatever you want”. Instead of that, here, they will have to say “we shall give you entertainment; let the Centre give us money”.

Santhanam’s warning about excessive centralisation, where states don’t have the power to tax, will sound prescient in today’s context.

“If this distribution of powers is adopted without further scrutiny,” he said, “in three years’ time, all the provinces will revolt against the Centre.”

That was 1947. GST came 70 years later. But it has taken exactly three years since the ‘one-nation, one-tax’ to be implemented, for the states to be up in arms against it.

Why The Power To Decide Taxes Is Important For Any Govt

Before I proceed any further, a word on why the power to decide taxes is important for any government. We commonly look at taxes as just a way for the government to raise funds to build roads, bridges, schools and hospitals, and do various other things that governments do. Taxes also have another crucial role. They nudge business and consumers to behave in the way a government wants them to.

You might say, the government shouldn’t have the power to tell us what to do. But every political party goes to voters with a particular political programme.

Taxes help it to not only raise money to spend on election promises, but also to direct economic behaviour along the lines of its ideology. After all, people vote for a certain vision of governance, whether it is represented by a charismatic leader or a political party, and tax-policies are integral to implementing that vision.

State Govts Have Realised That They Trusted Centre Too Much

Before GST, states had some leeway to use sales-tax, octroi and other local taxes to raise money and encourage – or discourage – specific economic behaviour. That is why most state governments, including the Gujarat government when Narendra Modi was CM, opposed GST. They only agreed when they were seduced by the guarantee of a 14 percent annual increase in revenue, for five successive years after GST was implemented. The assured revenue-growth was seen as a good enough reason to give up the right to formulate semi-autonomous taxation policies.

Now, state governments realise that they trusted the Centre far too much. States have faced problems with timely distribution of GST revenues since last year, well before COVID-19 hit India.

Now that tax collections have collapsed due to an ‘act of god’, the Centre has refused to honour the promise of assured revenue-hikes. Instead, states are being asked to borrow to pay for their budgeted expenditure.

Oppositon-Ruled State Govts Have Realised That GST Council Mechanism Doesn’t Protect Their Rights

State governments, especially those which are Opposition-ruled, have also realised that the GST-council mechanism does not protect their rights. Critics of GST had pointed out right at the beginning, that the dispute-resolution system is heavily skewed in favour of the Centre. This is especially true when the party that rules in New Delhi also rules a majority of states.

Since everyone was in a hurry to get GST started back in the summer of 2017, not even Opposition governments scrutinised the fine-print of the law to see if their rights would be protected if the Centre decided to bulldoze its will over them.

They are now discovering that the Centre can interpret the law in ways to suit its decisions, such as disallowing a vote over who should take the burden of borrowings, or allowing 21 states to exercise the option to borrow, even though it hasn’t been formally approved by the GST council.

In fact, the motley crew of Opposition finance ministers don’t even have the heft to make FM Nirmala Sitharaman give them any concrete answers in the Council meetings.

As Kerala’s FM Thomas Isaac tweeted on 12 October, “It is unfortunate that Union FM does not propose a decision in the Council or even make a statement (sic) what she is going to do, but choose to make the announcement in the press conference. Why does the Centre refuse to take a decision in Council? Total disregard for democratic norms.”

GST Woes: Why States Are Suffering

There is no doubt that the Centre’s refusal to honour its promise, that states will get a guaranteed 14 percent hike in their revenue share, every year, till 2022, undermines the political consensus that was built for GST. But it is equally true that states should have known that it is not possible to increase overall tax revenues at 14 percent per year, without super-fast economic growth. They must have known that India was unlikely to achieve that growth-rate, in the middle of a visible slow-down.

After all, if GST receipts, which make up the bulk of indirect taxes, were to grow at 14 percent, then either people would have to pay more taxes on the goods and services they consume, or nominal GDP would have to grow at the same rate.

If inflation was to be kept between four to six percent, then real GDP growth would have had to be 8 to 10 percent per year. This was an absurd expectation in 2017, given the shape of India’s economy at that time.

If states are suffering today, it is because they got greedy and refused to anticipate what was staring them in the face – that India’s economic slowdown will cause tax revenues to stagnate and bring the entire GST distribution system into a crisis.

Now, they are learning the truth of that old Italian saying – ‘big mouthfuls often choke’.

(The author was Senior Managing Editor, NDTV India & NDTV Profit. He now runs the independent YouTube channel ‘Desi Democracy’. He tweets @AunindyoC. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)