Goods and Services Tax (GST)

Need to deal with distortions built into GST

Note4Students

From UPSC perspective, the following things are important :

Prelims level : GST council decision making

Mains level : Paper 3- Issues with one state one vote system in GST council

The article highlights the issues with the one state one vote system adopted in the GST Council decision making.

Context

The Goods and Services Tax (GST) Council in India is still engaged in a discussion on whether life-saving and hard-to-come-by products should be taxed. Such delay in decision-making can largely be explained by the distorted design and incentive structure of the GST itself.

Imbalance in collection and distribution of taxes

  • The taxes collected under GST are accumulated by the Union government and a portion is transferred back to each state under a formula.
  • As is the case with most federal countries, there is a large imbalance in the collection and distribution of taxes between states.
  • this holds true also for income accrued to, and distributed, from the GST pool.
  • Four states — Maharashtra, Tamil Nadu, Karnataka, and Gujarat contribute nearly as much as the remaining 27 states combined.
  • Most federal countries exhibit this characteristic where a few large, rich, provinces or states contribute disproportionately.

Variation in dependence of States on transfers from the Union government

  • Only about 30 per cent of the overall revenue of the states mentioned above — Maharashtra, Tamil Nadu, Gujarat, and Karnataka — comes from the Union government.
  • But for the remaining 27 states, roughly 60 per cent of their revenues are obtained through transfers from the Union government.
  • For the smaller Northeastern states, these transfers from the Union government constitute 80-90 per cent of their total revenues.
  •  In effect, the states that contribute the most to the GST pool are the least dependent on transfers from the Union government while the ones that contribute the least are the most dependent.

Two problems in net-transfers in India

1) One-sided transfers

  •  In almost every federal union, net-transfers work to reduce differences in development between states over time.
  • However, Over the last 25 years or so, net transfers have become increasingly one-sided in India.
  • That is, the quantum of net-transfers diminishes, as states become more equal through such transfers.
  • But in India, the opposite has occurred.

2) Indirect taxes and cess

  • The Union government of the last seven years has greatly exacerbated this problem through two actions.
  • First, it has reconstructed the composition of taxation away from the fair and progressive channel of direct taxation towards the inherently regressive and unfair channel of indirect taxes.
  • Second, the Union has shifted a large proportion of taxation roughly 18 per cent of its overall revenues into cesses, a special form of taxes that remain outside the GST pool and hence do not have to be shared with the states.
  • Since 2014, cess revenues grew 21 per cent every year leading to a doubling in terms of its share of GDP.

Implications of these two problems for fiscal federalism

  • The combined effect of these problems is that all states (collectively) get a lower share of overall revenues.
  • Individual states face an ever-increasing disparity in the ratio of funds received from the Union as a proportion of taxes collected by the Union from that state.
  • This is an affront to fiscal federalism and an assault on “cooperative federalism”.

Issue of ‘one state one vote’ system

  • States that are more dependent on transfers from the Union want to maximise GST collections while states that are less dependent can afford to be more sensitive to citizens’ concerns.
  • The case of taxes on Covid products is perhaps the starkest instance of such differences.
  • Most large states are ready to forego this tax revenue for humanitarian considerations.
  • But 19 states representing the remaining 30 per cent of the population seem keen to continue to levy GST on Covid products.
  •  These are mostly smaller states.
  • Given the smaller population of such states, the adverse impact of Covid taxes will be minimal for them.
  • But they will reap the benefits of additional revenues from GST on Covid products levied on the much larger populations of the bigger states.

Conclusion

When direct tax policy decisions are legislated by Parliament, which has proportional representation from states according to their size of the population, indirect tax policy decisions should not be subject to one state one vote system.

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