A ‘Two-Third, One-Third’ Problem of Indian Federalism

Context: Finance Minister's "act of God" comment could fill many doctoral theses, and be the envy of divinity schools.

Reasons why Centre should honour its promise

• Promise by a sovereign entity: Sovereign trying to renege on a written promise made to its sub-sovereigns (Centre to states) shall not be equated with the notion of force majeure in commercial contracts, which lets parties abandon their commitments.

• Promised to fill the gaps to ensure a 14% growth in GST revenues

• Centre's Capacity: Centre is more capable than the states to raise the requisite funds, having access to the central bank, foreign dollar investors, the instrument of cess, and de facto monetization of debt.

Issues with the GST: 

• E-commerce and digital transactions too can erode the tax base of GST

• Reforms in GST are to either widen the net and remove exemptions or increase the standard rate to 12%, which requires national consensus.

• Mismatch between revenue and expenditure at the state or local government level:

• India's revised GST system should earmark revenues directly for the third tier

• As more citizens pay this consumption tax, of which some portion they know helps run their local government, there would develop a nexus between the demand for and supply of good governance. 

• "Two-third, one-third" problem: Two-thirds of revenue accrues to the Centre, but two-thirds of all expenditure obligations are on state and local governments.

Way Forward:

• Increase tax coverage: 

• If consumption is two-thirds of gross domestic product (GDP), we should ensure that the tax coverage is as comprehensive as possible.

• Current coverage is barely one-third since it excludes electricity, petrol, diesel and real estate, as also agriculture.

• Rationalisation of Rates: 

• Bring down from 18% to 12% as originally proposed by the Kelkar Committee
• If the standard rate of 12% is applied to half of GDP, then the total collection will be ?12 trillion, which would exceed current collections.
•  A 12% rate would increase compliance, reduce the need for arbitrary classification and discretion, and result in lower litigation. 
• World over, standard GST rates began much lower than India's 18%.

• "Revenue neutral rate" (RNR), as a reference peg, shall be discarded: We can't be bogged down by an elusive and ill-defined RNR, which may work as a reference point only in the short-run.

• Merit rate and Sin good rate: There should be only a few items in the merit rate and "sin" goods rate 

Conclusion: There is a God-given opportunity in these COVID times to radically reform GST and make it states- and taxpayer-friendly.