The recently concluded state assembly elections, which confirmed the dominance of three regional parties in the major states of West Bengal, Tamil Nadu and Kerala, are likely to be a turning point in the evolution of the goods and services tax. To the dissenting voice of West Bengal’s Amit Mitra, we will now see the addition of two new finance ministers, Palanivel Thiagarajan of Tamil Nadu, and KN Balagopal of Kerala. If we add other opposition-ruled states to this list, the demands for change are likely to be raucous.
Thanks to the Covid-induced collapse in revenues for both Centre and states, the GST power structure will come under increasing pressure. Even though the current voting rules allow the Centre to block any change it does not like, the reality is that most states, including not-so-vociferous BJP states, are chafing at the bit over the loss of economic autonomy under GST.
In the run-up to the next GST Council meeting on May 28, opposition-ruled states are calling for extending the GST revenue guarantee regime (which ensures 14% annual revenue growth for states) well beyond the five-year period ending June 2022. At a time when 2020-21 GST revenues fell short by Rs 2.35 lakh crore and fiscal 2021-22 may add another shortfall of Rs 2 lakh crore, the GST structure is already creaking under the weight of its own contradictions. Something has to give – and it probably will.
Any extension of the 14% revenue growth promise beyond June 2022 can be ruled out for it would mean raising the GST cess on “luxury items”, which fund the compensation to states, indefinitely into the future. In the process, the GST structure would end up squeezing those very products which are the most elastic sources of revenue outside tobacco and petroleum.
Before we go into what can, or needs, to be done, let us understand how we got here. First, GST was always a difficult political sell in a federal structure, and the only reason why states agreed to it was by promising them cheques whose sums increased by 14% every year. Over the last four years, GST revenues have always been in overall deficit barring one single month – April 2021, when revenues shot up to Rs 1.41 lakh crore. But this is likely to have been a one-off. It pertains to a month (March 2021) when pent-up demand after the first Covid wave peaked, and the second wave was yet to hit us with full fury.
Second, most economists did not get one thing right: It was assumed that since GST is a destination-based tax, consuming states (many of them poor) would benefit more than producing states. This mistaken belief was decisive in getting the poorer states to sign up quickly for GST. The richer ones followed based on the compensation promise. It is worth pointing out that the previous Kerala finance minister, Thomas Isaac, was a GST believer, while his replacement in the re-elected Pinarayi Vijayan cabinet, Balagopal, was always a GST sceptic. The latter strongly believed that GST would erode state fiscal autonomy, while Isaac believed that Kerala would benefit from GST as a consuming state.
Third, another reason why most states willy-nilly agreed to pool their fiscal sovereignty in the GST Council was the decision to allow them to tax petro-products and alcohol on their own, which gave them some revenue control. This is why even after four years of GST, no state wants to bring petroleum under GST.
To repeat, the realities we are up against are the following: (a) The 14% revenue growth guarantee cannot be sustained after June 2022 unless growth mysteriously spikes to unexpected levels in the third and fourth quarters this year, and sustains consistently after that in the coming years; (b) no matter what we do in this year, and probably in the next, most spending will have to be focussed on healthcare, not only for the purchase of vaccines but also to ramp up healthcare infrastructure, and investments in healthcare do not bring any immediate revenue bumps; and (c) political pressures to devolve more resources to states will keep increasing as Modi government finds strong regional pushback. If BJP fails to hold on to Uttar Pradesh next year, it will be a political lameduck, assuming it is not already one.
Is there a way out? The best way to arrive at a solution is by ruling out bad compromises first. One, the blank cheque of guaranteed revenue growth for states has to be withdrawn. Future compensation should be linked to economic growth and states’ own efforts to improve GST compliance and reduced administrative costs in general. Two, in the process of renegotiating the GST regime, what cannot be compromised are the economic efficiencies we have achieved with GST, including the end of a cascading tax regime, and freedom of goods movement between states. This implies that GST can only be improved by expanding its scope to newer items, and not by reimposing local taxes or imposing high cesses. Three, no solution can avoid mentioning the elephant in the room: Devolving more economic power to states.
Fixing GST will mean fixing Centre-state power imbalances constitutionally and through fiscal compromises. States are powerful politically, but their fiscal powers are not commensurate with their growing responsibilities. As a former CM, Narendra Modi knows this more than anybody else. He should fix this imbalance. He will find both political and economic benefit emerging from this rebalancing of Centre-state power equations. GST 1.0 is past its sell-by date. We need to start talking GST 2.0. And fiscal devolution.
Views expressed above are the author’s own.
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