The Goods and Service Tax (GST) Council has been hailed as a model federal institution, where both states and the centre are represented, and consensus is arrived through a detailed deliberative process. Until the 38th GST Council meeting in December 2019, there had not been a single instance of voting, despite strong differences of opinion voiced on many issues. They were settled in a spirit of give and take. That acrimonious meeting on the modification of the existing rate structure of lotteries was indeed a sign of changing times. By the end of the next year, the Council was on the brink of a serious disruption with the centre and states sharply diverging in their stand regarding the payment of GST compensation.
The emergence of GST has been the most important event in the history of centre–state relations since the adoption of the Indian Constitution. According to the Constitution, powers to levy personal income tax, corporation tax, excise (other than on alcohol for human consumption), customs duties and service tax were the domain of the centre. The responsibility for taxes on intra-state purchase and sale of goods lay with the respective states. The tax on intra-state trade took the form of sales tax, turnover tax, surcharges, luxury tax and various types of entry taxes. Sales tax, which was imposed at the first point of sale, and for some commodities at multiple points of sale, was replaced by value added tax (VAT).
Inter-state sales were subject to the levy of central sales tax (CST), a central tax which was, however, levied and collected by the state in which the transaction originated. The central excise and service tax and commodity taxes of the states, other than those on petrol and alcohol, were merged into GST, to be jointly administered by centre and state. In effect, the states had to surrender a much higher share of their taxation powers, while the centre was still left with many of its buoyant taxes. Even according to the original constitutional arrangement, the states accounted for only 40 per cent of the combined revenues of governments, and this asymmetry worsened with the passage of GST.
Nevertheless, GST has been hailed by some as an exhibition of robustness of Indian federalism, because this major change was brought about by avoiding acrimonious controversies through elaborate negotiations in a spirit of give and take between centre and states, and between states. The first objective of this paper is to broadly outline this process.
We shall then go on to examine the functioning of GST during the last four years to assess whether the high expectations of GST have been realised in terms of revenue buoyancy, ease of doing business and positive impact on growth. The outcomes have been far from expectations. Worse, the give-and-take attitude that characterised the run-up to the new taxation system has virtually evaporated.
Finally, we conclude that, based on a review of the experience so far, a comprehensive overhaul of the GST regime is required so that federal concerns are addressed, buoyancy of revenue is assured, and the GST Council truly becomes an institution of federal cooperation.
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The emergence of GST: An instance of negotiated federal settlement
There was a growing concern about the complexity of the tax maze of multiple taxes and numerous rates of different taxes in states, together with their cascading effects. Sales tax was levied on commodities that had been subjected to excise duty (and at times additional excise duty). Central sales tax was levied in the case of inter-state sales, besides various types of entry taxes. The cascading impact imposed a high burden on consumers and eroded the competitiveness of Indian exports. The buoyancy of sales taxes also exhibited a declining trend. The main reason was that the tax system was officer-centred and could easily degenerate into corruption and inefficiency. The response was to move to the multi-point sales tax system so that the leak could be identified at any of the points by following the trail. It made the system even more cumbersome.
The reforms of the 1990s opened an era of deregulation and delicensing, and private capital began to negotiate to bargain for greater advantages from state governments for locating their investment. The states began to offer competitive tax holidays to attract big private investment, a ‘fiscal race to the bottom’ (Rao and Rao, 2005). Floor rates below which sales tax rates ought not to be reduced were suggested.
Empowered committee of finance ministers and VAT
It was in this scenario that GST was sought to be replaced by VAT for the intra-state trade of goods. Every point of sale above a threshold limit would be a point of taxation, but only net tax, after allowing for input tax incurred at the point of purchase, was remitted, thereby removing the cascading effect. The uniform rates, model procedures and framework of the new tax system were arrived at through the consensual decisions of the Empowered Committee of State Finance Ministers in which all the states were represented by their finance ministers.
Although there was no constitutional compulsion to fix standardised rates, it was remarkable that the states, after elaborate discussions, came to a consensus. The rates were standardised at 1, 4 and 12.5 per cent, respectively. A few years later, they were raised to 2, 5 and 14.5 per cent, respectively. There was strong criticism that in a country like India, with vast diversity, uniform tax rates would not be a desirable tax reform (Mitra, 2003). It was also alleged that the new rates were not revenue neutral. The West Bengal finance minister Ashim Dasgupta was Chairman of the Empowered Committee and played an important role in evolving the consensus.
Value added tax was implemented from 1 April 2005 onwards by most states, though some, viz., Tamil Nadu and Uttar Pradesh, implemented it later.
After teething troubles, VAT revenues proved to be buoyant as the new self-policing system mopped up the slack that existed in the tax system. However, after 2012–2013, there was a decline in the growth rates of tax revenue. A major blow to the VAT system was the adverse judgement of the Supreme Court on the levy of entry tax. The VAT tax was an intra-state tax and, therefore, without the entry tax there was no possibility of taxing commodities that were brought from outside the states. This was particularly the case for a consumer state like Kerala. There was a substantial reduction in the growth rate of revenues under VAT in many states, from an average of 16–18 per cent from 2005–2006 to 2012–2013, to 8–10 per cent per annum starting 2013–2014. The expenditure burdens of the states, especially in the revenue account, were downwardly inflexible. This prompted the states to look to expand their tax bases.
This excerpt from The Working of the Indian Constitution has been published with permission from IIC Quarterly.