GST and its impact on state revenues

 







The launch of the Goods and Services Tax (GST) was expected to usher in amongst other things, better tax compliance leading to increased tax efficiency, buoyancy and consequentially, higher revenue. As the tax reform enters its fifth year, there have been some strident voices and murmurs amongst a few states suggesting that GST has led to their revenue's being impacted adversely. The states have still not got over the angst of having lost some powers of taxation.
An issue that has distorted meaningful discussions has been compensation. It is necessary to put this matter in perspective. Compensation was guaranteed by the Centre for a period of 5 years, to be calculated on the base revenue of 2015-16 assuming thereon a 14 percent growth. In the din of the heated discussions, it is forgotten, as the study by Manish Gupta and Indira Rajaraman shows (Is the 14% revenue guarantee to states justified? - Economic & Political Weekly, Nov 28th 2020, Vol. LV No. 47) just five states had in respect of the subsumed taxes, growing at a rate higher than 14% pre-GST. The study goes on to establish that the all-states average growth rate of the subsumed taxes for the period 2012-13 to 2015-16, varied between 7.59 percent to 7.67 percent - a huge difference of 6.33% to 6.41% between the actual growth and the growth assumed for the purpose of compensation. The gap between the actual revenue and the guaranteed amount has to be seen in this light. Or to put it differently, the ‘loss’ is the consequence of this mathematical gymnastics and is notional.

This has to be juxtaposed with the fact that there was a significant negative impact in 2019-20 because of the economic slowdown. As against the budget estimate of 12 percent, nominal GDP grew at 7.2 percent. 2020-21 was worse. The pandemic, lockdown and severe impact on the economy resulted in GDP contracting by 7.3 percent. All this meant a significant reduction in revenues-both of the Centre and states. Expenditure necessarily increased to meet the health and economic crises. The economic downturn also meant that GST compensation cess collection was also adversely impacted. In 2019-20 as against the requirement of Rs 1.65 lakh crore there was a collection of about Rs 95,444 crore leaving a gap of about Rs 70,000 crore. The requirement in 2020-21 rose to about Rs 3 lakh crore - and the shortfall to Rs 2.3 lakh crore. This led to the much-debated Centre’s proposal of two options, both of borrowing. Much heat was generated since the Centre sought to make a distinction between shortfall because of the implementation of GST and as a consequence of the pandemic. The issue was resolved – however, a trust which is the bedrock of federal relations got severely stretched. The shortfall was to be made good by permitting the states to borrow through the issue of debt under a Special Window. Borrowings were permitted by the Centre to increase from 3 percent to 4 percent of GSDP and up to 5 percent, subject to caveats. The 42nd GST Council recommended that the levy of compensation cess be extended beyond the transition period of 5 years-ie. beyond June 2022 for ‘such period as may be required to meet the revenue gap’.

So, a study of the impact of GST on state revenues would be worthwhile in the period when the economy did not have face unprecedented headwinds. In this regard, the RBI’s annual report on State finances based on the study of State’s budgets for the period 2019-20 makes interesting reading. Own revenues of States consisting of taxes on income and expenditure, taxes on property and capital transactions and taxes on commodities and services constituted on an average of 44.7 percent of the total revenue. Non-tax revenue consisting of interest receipts, dividends and profits and services-general, social and economic constituted another 7.8 percent. The remaining 47.5 percent came from central transfers-devolution and grants. While undoubtedly a greater share of state revenue was subsumed under GST (about 50 percent for states and 37 percent for Centre) the fact remains that post -GST, collections under SGST has consistently exceeded CGST because of the very scheme of things; CGST being adjusted against IGST and the input tax credit mechanism. One must also keep in mind the fact that the effective weighted average GST rate came down from 14.4 percent at the time of inception (which was lesser than the effective weighted average rate pre-GST) to 11.6 percent in just two years. All this meant lesser buoyancy, lesser revenue and greater stress on the Centre to 'compensate' - with even the cess being collected for this purpose not being sufficient.

The RBI report has the state-wise own tax revenue data from 2004-05 to 2019-20. Except for 8 States (Arunachal Pradesh, Himachal, J & K, Manipur, Mizoram, Nagaland, and Odisha) which have shown a fall in revenue in 2018-19 when compared to 2017-18, all other states have an increase in revenue collections. Tamil Nadu for instance from Rs 96,472 crore in 2017-18 to Rs 1,10,178 crore the following year; and in the same period, West Bengal from Rs 57,701 crore to Rs. 61 617 crore; Punjab from Rs 31,496 crore to Rs 33,073 crore; NCT Delhi from Rs 35,717 crore to Rs 38,400 crore. The loss if any in respect of all the States is only when 14 percent assumed growth is calculated on the 2015-16 revenue. And hence all the states were beneficiaries of compensation cess. But to blame this loss on GST per-se would be incorrect.

Going forward it is essential that the tax base be expanded with the inclusion of petroleum products. Both the Centre and the States collect substantial revenue from petroleum products and would be reluctant to do so. Taxes, both of the Centre and State constitute nearly 60 percent of the cost of petrol with cess being a major component. Cess particularly hurts the States since it does not get shared. As the XV Finance Commission has pointed out total cess and surcharge as a percentage of the gross revenue had grown from 12.2 percent in 2016-17 to 20.2 percent in 2019-20.

As has been suggested the guarantee of compensation has lulled states into revenue complacency. Tax administration has to be strengthened. In a reply to a Lok Sabha question, the Government had stated that between July 2017 and December 2020, 3852 cases of fake invoices with fake input tax credit availed to the extent of Rs 35,620 crore had been detected. This is humongous and needs to be checked with informed data analytics and close cooperation between all agencies. The combined tax to GDP ratio of the Centre and States has to increase from the present of about 17 percent.

States will have to be alive to the very strong possibility that the Centre is unlikely to extend the guarantee of compensation beyond June 2022. And gear up accordingly to meet the new reality.

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