Post GST, prohibition could be an expensive experiment for states

If any state implements prohibition, it will have to forego the excise revenue from sale of alcoholic beverages

Prohibition, or a ban on the sale of alcoholic beverages, is a measure listed in the directive principles of state policy in the constitution of India. These guidelines are not judicable, but as the name suggests, expected to be followed voluntarily by governments. After Nitish Kumar’s big victory in the 2015 assembly elections in Bihar, where he promised to impose prohibition if elected, the policy has been gaining political traction. J Jayalalithaa toyed with the idea in Tami Nadu before her death. The previous Congress-led government in Kerala had tried partial prohibition, envisaging a complete ban on alcohol by 2025. The newly elected government in Andhra Pradesh is also taking steps to curtail the liquor business, and has announced a takeover of all retail outlets selling alcohol. The political and moral arguments around prohibition notwithstanding, it could be an expensive experiment for state governments, especially in the post-Goods and Services Tax (GST) era.

An analysis of the Reserve Bank of India’s Study of State Finances, which was released this week, corroborates this view. GST has been a landmark tax reform in India. It abolished multiple taxes on goods and services across India’s 29 states and replaced them by uniform taxes. This has brought much-needed parity in taxes and cut a lot of red tape in facilitating free movement of goods and services across India’s states.

While GST has brought these benefits, it has also eroded the fiscal autonomy of states. As GST rates are decided in the GST Council comprising all states and the centre, individual states have much less freedom to decide tax rates according to their needs. In the post-GST period, the share of states’ own revenues in their total tax revenues has come down. This means that their dependence on the central pool of taxes has increased. India’s fiscal federalism has a provision of sharing of central taxes with state governments. The terms of this distribution are decided by the Finance Commission every five years. The fifteenth Finance Commission is expected to submit its report next month. There is speculation that the commission would tilt the fiscal balance in favour of the centre.

The centre is not expected to share revenue earned through cess levied on various taxes. A Mint analysis by Tadit Kundu has shown that the share of cess in central government revenues has been steadily increasing under the current government and has reached almost 15%. This means that the divisible share of central revenues has been steadily coming down.

To be sure, states do have the power to tax some important goods and services even in the post-GST regime. Petroleum products, tobacco, alcoholic beverages are some such commodities. Another major source of state government revenues is the stamp duty levied on property transactions. Tax generating ability of petroleum products is contingent on international oil prices. Both central and state governments face pressure to cut taxes when oil prices are higher. This was seen last year when both central and state governments cut excise and value added tax (VAT) on petrol and diesel to bring down retail prices of petrol and diesel.

This leaves state excise (from alcoholic beverages) and stamp duty and registration fees (mainly levied on sale of property) as the major sources where state governments have autonomy to levy taxes. If one were to exclude SGST (rates of which are decided in the GST Council) from states’ own revenues, the share of state excise and stamps and registration fees in states’ own revenues has increased significantly, from around 20% to 40%, in the post-GST regime.

The importance of these two taxes in states’ own revenue shows an interesting trend. State excise was twice as important for states compared to stamp and registration fees in the early 1990s. This started changing as India’s real estate boom started in the early 2000s, and stamp and registration fees overtook state excise in terms of share in states’ own tax revenues by 2005-06. This growth stopped from 2008-09 onwards, the year when the financial crisis struck the US, triggering a global slowdown. As of now, state excise revenues seem to be surging ahead of stamp and registration fees in terms of share in states’ own revenues. Any state which implements prohibition will also have to forego state excise which comes from sale of alcoholic beverages. This will also entail surrendering a major, and more importantly, autonomous source of revenues for the state exchequer.