Calcutta Notebook

Autonomy in GST

Bharat Jhunjhunwala

The union government has constituted a Group of Ministers to review the entire GST system. The fundamental issue facing the government today is that the states may be in big trouble beginning July 2022. The Union Government had promised while introducing GST in 2017 that it will compensate the states for any loss of revenue after the implementation of GST for 5 years. It was projected that GST revenues will increase by minimum 14% per year. Thus the state governments were entitled to receive 14% more money from GST every year irrespective of what the actual GST collection in their states was. For example, the GST collection in Punjab may be Rs 4,000 crore in 2020-21 but it may still get Rs 7,000 crore from the Union Government because it is entitled to receive 14% more every year since 2017. However, this system will come to an end in June 2022. Thereafter the states will only get the GST that is collected within their own state.

The situation is serious because states are becoming ever more dependent on the compensation received from the Union Government. The GST compensation constituted only 24% of the revenue of the state in 2019. This has increased to 58% in April-July 2021. Of, course, a major cause is the Covid-19 pandemic which has led to the reduction of GST collection in most states. However, it means that the states will face deeper problem when the compensation system comes to an end in June 2022. It is for this reason, perhaps, that Karnataka has asked the Union Government to consider extending the compensation system for another 3 years. But such an extension by Union Government is unlikely and state governments will be in deep trouble beginning July 2022.

The fundamental problem with GST is that the autonomy of the states has been restricted. Puducherry, Himachal Pradesh, Goa, Jammu and Kashmir, Uttarakhand, Jharkhand, Assam and Chhattisgarh were collecting higher rates of sales tax compared to other states before GST was implemented. Even if the total quantity of goods sold in their states was less, they could still collect more revenue as sales tax because they could increase the rates of sale tax. This freedom is no longer available to them anymore. As a result, every state will get only the amount collected from GST within its state at the rates specified by the GST Council for the whole country and will not be able to increase the rate of GST to collect more revenue. This will lead to many states losing as much as 20 to 30%, if not more, of their revenue and there will be a huge crisis in the country.

The fundamental reason that India adopted GST was to smoothen the functioning of the economy. GST has indeed made trade simple on two points. First, the classification of all goods across the country has been standardised. Previously, kraft paper could be classified as “paper” in one state and “packing material” in another state leading to disputes on the border. Such disputes are no longer possible. Secondly, the whole system of issuing “C” forms for the transport of goods from one state to another has been dismantled and movement of goods has become smooth. However, this has come at a huge cost of challenging the autonomy of the states as outlined above.

In this respect one can take a lesson from Canada and United states. In Canada different states levy different rates of sales tax in addition to the GST which is levied by the central Government. Alberta, for example, has only 5% Federal GST. British Columbia has 5% Federal GST plus 7% Provincial Sales Tax. Ontario has 13% Harmonised GST which includes both Federal and Provincial taxes. Yet, there arises no problem in the movement of goods from one state to another and they do not have requirements such as the “C” form. Reason is that they have a standard classification which is applicable to all states along with autonomy to the states to fix the rates of tax. There are no disputes of classification. Every seller collects GST on the goods based on the rate applicable at the point of sale. For example, a manufacturer in Alberta will collect 13% Harmonised GST from a buyer based on Ontario but collect only 5% GST from a buyer based in Alberta. In this manner the autonomy of the states to levy different rates of GST has been protected while movement of goods from one state to another is seamless. Similarly, in the United States there is no GST. Every state is free to levy different rates of sales tax on goods sold within its borders. Some states levy no sales tax at all. All their revenue comes from state income tax. In other states, there are varying rates of sales tax yet there is free movement of goods. These two examples indicate that the basic purpose of free movement of goods can be achieved without insisting on a uniform rate of GST.

The challenge before the Group of Ministers is to proactively consider the situation that will arise for the states in July 2022 when the states will lose their right to be compensated by the Union Government for the less collection of GST within their borders. At that time, the states will face a huge drop in their revenues and may be even forced to withhold or cut the salaries of their employees. They will certainly have to cut their capital investments such as in the roads and other infrastructure. Therefore, the Group of Ministers should consider modifying GST to allow states to collect different rates of GST as it is done in Canada and USA. In this way thereby free movement of goods can take place while the states are allowed to impose different rates of GST according to their own needs and assessments.

[Bharat Jhunjhunwala, Formerly Professor of Economics at IIM Bengaluru]

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Vol. 54, No. 21, Nov 21 - 27, 2021