By Manoj Kumar Sahoo & Prashanta Chandra Panda in Gandhinagar, August 31, 2016 : The recently passed GST Bill in the Rajya Sabha has been hailed as a long pending significant tax reforms in India and it has the potential to relieve the economy from taxation hiccups and usher a new era of higher growth.

However, the multiplicity of taxes between Centre and States, and also the flexibility and freedom granted to the states by the Constitution to levy various kinds of taxes under the structure of fiscal federalism are surely going to be affected by the implementation of GST.

These concerns were raised by the states in the earlier Finance Ministerial Meeting during the UPA regime. Subsequently, the Centre has agreed upon to compensate the states for any revenue loss arising due to the implementation of GST from 1st April 2017
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It is clear by now that under the present structure of GST some states might lose revenue and some might gain under the new pan-Indian tax regime. GST will do away with the multiplicity and duplicity of the indirect taxes and a dual structure with one rate applicable to the centre and another applicable to the states will be implemented.

Under the new GST structure, the states where the goods or services are consumed will collect the taxes. This means losses could be more for the producer states and the consumer states will be benefitted. That is leading to the Compensation argument by the States from the Centre for loss of their tax revenue. The Centre has decided on a five-year compensation scheme for the states that but states don’t want to agree on a limited time frame out of the fear that five year may not be enough for full revenue compensation.

Here the Centre’s earlier VAT compensatory scheme may be of some vital reference implemented on 1 April, 2005. The centre in order to compensate the states for the revenue loss due to VAT implementation had came out with a compensation structure of 100 per cent in the first year, 75 per cent in the second year and 50 per cent in the third year.

But the effective implementation of VAT resulted into good growth in revenue, and hence the Centre had not much financial burden on account of VAT. It received only INR 13,167 crore worth of compensation claims by the states by January, 2008. This scenario may be expected in case of GST also, but only in the long run, and not in the short run.

As GST is going to have differential impact on the more industrialized manufacturing states and the relatively less industrialized and even economically disadvantaged states, it is but legitimate to expect the states concerns as genuine. That is, the two major concerns raised by the states in the Lok Sabha debate- one, loss of revenue and two, loss of fiscal autonomy.

In terms of loss of revenue, despite the Finance Minister’s assurance the manufacturing states are more worried. The reason being the nature of GST vis a vis VAT. VAT is the current tax regime by which states collect indirect taxes. But VAT is an origin-based tax while GST is a destination-based tax. In the origin-based tax system, tax is collected at the location of the supplier of the good whereas in the destination-based system, tax in collected at point of location of the consumer of a product.

Tamil Nadu, Maharashtra and Gujarat are among the more industrialised and manufacturing states from where intra-state and inter-state movement of goods takes place heavily. And hence they fear significant losses of revenues particularly in case of inter-state movement of goods from states, in which case GST tax will be collected in other states.

Likewise, the overall macroeconomic equilibrium of taxation can be achieved in the medium run by the off-setting likelihood of revenue increases in the consuming states by the implementation of GST. And those states may need the full amount of revenue compensation for five years. This balance of funds can be utilized to compensate loss making states- even for more than five years- if not for ten years as some states demand.

The recent Constitutional amendment talks of assurance of revenue compensation only for 5 years with the modus operandi of 100 per cent of loss compensation in the first 3 years, 75 per cent in the 4th year and 50 per cent in the 5th year.

States like West Bengal had also raised concern regarding loss of revenue. And alternative loss compensation mechanism like allocating a significant share from the coal block auction to the coal producing states is being thought out by the Finance Ministry from which West Bengal can be benefitted if implemented.

Though entire revenue loss of the respective states are not available, but certain components of their taxes which are likely to be abolished by the implementation of GST can be estimated from their state budgets. For example, Tamil Nadu is estimated to loss annually about INR 3,500 crore from abolish of Central Sales Tax (CST) in the GST regime and Maharashtra is poised to lose INR 14,000 crore from its Octroi collection.

States get tax revenue by levying sales tax or VAT on goods sold within their territory and get a share in Central Sales Tax (CST) from the centre on sales made outside the states. To compensate for CST losses, Government has proposed a 1 per cent additional tax on inter-state trade of goods for two years or more to be transferred to the states.

But if one takes into account the likely cascading effect of multiple imposition of this additional tax on inter-state sales of goods, the compensatory impact of the revenue generated from the tax will not be free from its negative impact in the form of net slow down in the demand and sales of those goods due the inflationary impact it might generate on account of increase of cost in the supply chain when a product moves from one state to another and every time fetches an additional tax from state to state.

However, the Government expects the service tax revenue generated by states from increased tax collection on services will suffice for losses on account of abolish of major state level taxes like octroi, entertainment tax, luxury tax after GST. The GST will subsume all indirect taxes like excise, sales and other state level service taxes. Currently, service tax is imposed at 15%. As indication goes by GST rate is going to be more than this leading to overall larger service tax collection.

GST also involves ‘dual control’ system of tax collection. In the new regime, GST will be levied in two forms: one Central GST (CGST) and another State GST (SGST). States want to control small businesses in their hand particularly of INR 1.5 crore turnover and seek to bring them under their taxation purview of SGST. Moreover, states want additional taxes on tobacco products and want it under CGST which is currently with the Centre. These matters have not been resolved in the GST council.

Matters of fiscal autonomy of the states are also not resolved yet by the GST Council. The power to impose taxes even on SGST matters will not be in the hands of the states in the new regime. States cannot change tax rate, cannot propose new taxes, cannot include new items under tax purview unless approved by the GST Council where the Centre will have a significant say.

So even if the states may be compensated in the medium run against their tax revenue losses, the larger question of fiscal autonomy of the states lingers on unto a tricky track fiscal federalism, where supportive and constructive resolving of contending issues with larger national interest and regional balancing of federal taxation structure will be the foundation on which the new tax regime has to be based upon.

*(Manoj Kumar Sahoo and Prashanta Chandra Panda are faculty of Economics at Pandit Deendayal Petroleum University, Gandhinagar, Gujarat, India).