From the promise of a grand bargain to a “betrayal of trust”, India’s bumpy three-year-long journey toward an integrated Goods and Services Tax (GST) has hit a serious roadblock. The current fracas over the promised compensation at a guaranteed rate of revenue of 14% by the Centre to states for losses associated with GST implementation risks undermining not only an important economic reform but more crucially, India’s already precarious fiscal federal consensus. Regardless of how the impasse is resolved, the Centre, by refusing to pay states their constitutionally-promised dues and seeking to transfer the onus of revenue loss on to states has delivered a severe blow to “cooperative federalism”.
The significance of the controversy is best understood by locating the GST compensation debate within India’s fiscal federal architecture. Constitutionally, India’s fiscal federal arrangement has several centralising features. Over the decades, New Delhi drew on these powers to encroach on expenditures that are firmly in the purview of states. States, from the Sarkaria commission report in the 1980s to the controversy over the terms of reference for the 15th Finance Commission, routinely complained against this centralisation. Greater fiscal decentralisation was a regular demand from chief ministers.
But this never translated into meaningful reforms. Indeed, the impulse of successive central governments was to deepen centralisation — even reneging on a commitment to compensate states in full while phasing out the central sales tax — resulting in a breakdown of trust in Centre-state fiscal relations.
Against this backdrop of distrust, the compromise struck under the GST was remarkable. States voluntarily gave up fiscal autonomy in favour of long-term economic efficiency, paving the way for the articulation of a framework of co-operative fiscal federalism. GST’s institutional backbone, the GST Council, comprising finance ministers from the Centre and states, became a widely celebrated poster child for cooperative federalism.
At the heart of the GST compromise lay the promise of “Acche Din” (good days; also a campaign of the Bharatiya Janata Party ahead of the election). GST, the Centre assured, would result in revenue buoyancy and committed to a guaranteed growth rate of 14%. States drove a hard bargain. For fiscally-strapped states, the promise of generous compensation overrode concerns of fiscal autonomy. The Centre on its part, perhaps blinded by the promise of acche din and its own centralising impulse, took on an unrealistic revenue risk.
These compromises came at the cost of a carefully-designed GST. Don’t forget that even before Covid-19, GST had run into serious challenges ranging from a complex rate structure to the tyranny of the e-way bill system, which contributed to the growth slowdown and associated revenue shortfalls. Rather than a shining example of cooperative federalism, GST, in its current form, is an imperfect compromise and a work in progress.
Regardless of its flaws, the compensation guarantee was critical to bridging the existing trust deficit in Centre-state relations and formed the basis of the GST federal bargain. Since its launch, the centralising impulse has over-ridden the co-operative expectation of GST. Revenue transfers and compensation payments have been repeatedly delayed. States have little recourse, except to write letters and complain. The current stand-off, when state revenues are at an all-time low, breaks the foundations of the agreement.
What makes the Centre’s actions even more egregious is that its refusal to honour its GST commitment comes on the back of another failed promise of cooperative federalism — increased tax devolution. The 14th Finance Commission sought to deepen fiscal decentralisation by mandating that the states’ share in the divisible pool of taxes be enhanced from 32% to 42%. Having accepted, indeed welcomed this recommendation as a watershed for cooperative federalism, the Centre has carefully avoided fulfilling it. Actual transfers to states as a share of gross tax revenue have been in the range of 33%-35%. In addition, since the early days of the Covid-19 necessitated lockdown, states have repeatedly appealed to the Centre to fulfil its sovereign duty by deploying its financial powers to provide additional resources. These appeals have fallen on deaf ears. The result, a deep trust deficit.
What now? States ruled by non-BJP parties have rejected the Centre’s proposals that seek to place the burden of borrowing on them, suggesting quite rightly, that it is the Centre’s responsibility and well within its capacity (in light of India’s centralised fiscal architecture) to borrow to meet its commitments. Not only is this in line with the Centre’s constitutional obligation, it also makes macro-economic sense. In addition, the Centre should devise a formula-based Covid-19 grant to states to ensure they have access to much-needed additional resources. There are many innovative proposals on finding the money. It is the Centre’s commitment that is the hurdle.
Several interlocutors, including Arvind Subramanian, a key framer of the original GST compromise, have suggested states meet the Centre halfway by settling for a more realistic compensation. But against the backdrop of the yawning trust deficit, this is a hard ask.
Importantly, the debate has now taken a political colour with the BJP-ruled states choosing between silence and abiding by the Centre’s line, thus pitting themselves against other states. This closes the space for a genuine compromise. The Centre must live up to its constitutionally-struck bargain. The future of fiscal federal relations is at stake.
Yamini Aiyar is president and chief executive of Centre for Policy Research
The views expressed are personal