WHY THE GST FRAMEWORK IS IN TROUBLE
T he switch to the Goods and Services Tax (GST) in July 2017 was a historic moment in India’s fiscal trajectory. It scrapped a plethora of central and state taxes and paved the way for a uniform tax regime and a common market across the country. Ideally, there should have been fewer GST slabs, but the idea was always to move to this once the regime stabilised.
Like all big-ticket reforms, GST had to wait for a long time to see the light of day. Reforms such as GST are difficult to implement not because they do not have enough traction as ideas, but because the transition from the status quo to a new framework is challenging. In GST’s case, the shift required both the Centre and states to give up their sovereignty in levying indirect taxes to the GST Council, a body which includes representation from the Centre and the states. Still, the loss of fiscal sovereignty was much greater for states.
The biggest question which needed to be addressed before shifting to GST was what if revenue collections fell short of expectations? This was a matter of deep concern for the states, which feared a loss of revenue. The final deal was struck, under the stewardship of the late Arun Jaitley, who brought in his remarkable consensus-building skills as finance minister, with the Centre offering a guarantee to the states. They would be assured of 14% growth in revenues for the first five years of GST. This money was to be realised from cess on luxury and sin goods.
Three years after the implementation of GST, many state governments (run by non-Bharatiya Janata Party forces) are alleging that the Centre has reneged on this promise. Their objections seem valid. The Union has not paid the constitutionally mandated ₹1.5 lakh crore of GST compensation to states for the months of April-July in the current fiscal year. The reason is that cess collections have not been enough to make payments. It also expects that the total shortfall in GST compensation to the states will be ₹2.35 lakh crore in the current fiscal year. Of this, the Centre claims, ₹97,000 crore is on account of GST implementation and the rest is due to the external shock of the pandemic.
The states have been told that they can exercise two kinds of borrowing options to meet this shortfall — either borrow the entire ₹2.35 lakh crore, or borrow ₹97,000 crore. The Centre has said it will work with the Reserve Bank of India (RBI) to facilitate this process. The repayments will be made by extending the period of cess on luxury and sin goods. As some states are claiming, there is basically one option on the table. The states have to borrow to raise the money, which, the Centre owes them. The GST Council will meet again next week to resolve the matter. Irrespective of the nature of the final resolution, state governments are bound to feel let down. The GST experience will also make them chary about agreeing to change the status quo for market-friendly reforms in the future. A growing distrust between the Centre and the states does not bode well for our democracy.
To be sure, the current economic situation, which caused this crisis, is indeed extraordinary. The Indian economy will witness a contraction, of at least 5% this year. Revenue collections will miss projections made in February, before the pandemic spread. However, GST’s problems go back to the pre-Covid-19 period. While most people agree that a unified tax was desirable (this continues to be the case), its revenue-generating abilities were grossly overestimated initially, especially because slabs have gone through constant revision. Just one example should make this clear. The budget estimate for Centre’s GST collections was ₹7.43 lakh crore in 2018-19, the first full budget after GST’s implementation. This number is just ₹6.9 lakh crore in 2020-21 — so, a tax head is expected to shrink even when GDP has grown. Even the reduced targets have not been realised. The Centre’s
GST collections in 2018-19 and 2019-20 were only 78% and 90% of budgeted targets.
Even finance minister Nirmala Sitharaman, while speaking at the HT Leadership Summit in December 2019 acknowledged this point. “I am not saying that people did it (reduced rates) thoughtlessly, but in the enthusiasm to reduce taxes, that framework which was originally agreed at stage one of GST was distorted,” Sitharaman said, explaining that lowering the tax rate impacted the input tax credit and transferred more taxes to the buyer. A Reserve Bank of India report on state finances corroborates Sitharaman’s point. Against the revenue-neutral rate of 15.3% which was recommended by the Arvind Subramanian Committee, the weighted average GST rate has been falling continuously and was just 11.6% in July and September 2019.
A similar set of processes is underway again. Even as Sitharaman suggested, on August 25, the extension of cess on luxury and sin goods beyond the initial period of five years, she hinted towards reducing GST rates for two-wheelers. While tax breaks to boost the economy by spurring demand are always welcome, they cannot be decided without consideration of their fiscal implications.
GST has faced other issues too. Its teething troubles — many believe that it was implemented without adequate preparation — generated large headwinds for economic activity. The preCovid-19 deceleration in the Indian economy — GDP growth fell from 8.3% in 2016-17 to 7% in 2017-18, 6.1% in 2018-19 and 4.2% in 2019-20 — followed the back-to-back economic disruption from demonetisation and GST.
India’s GST experience raises a bigger point, and perhaps highlights a future lesson, about policy reforms. All reforms, no matter how desirable they are in principle, need to be thought through carefully before being rolled out. It is always tempting for regimes to fast track them, without weighing all pros and cons. This process becomes easier when a regime has tremendous political capital — like the BJP has had from 2014 onwards. However, when the crunch comes, like it has come for GST compensation today, or when there is more-than-expected collateral damage from reforms, both the government and citizens are left to face the consequences.
The forthcoming GST Council meeting should do all it can to preserve the sanctity of India’s fiscal federalism in letter and spirit. This process cannot be complete without an honest introspection of the GST’s formulation and evolution.