GST: The simple, Good Faith and Only Solution

Context: The acrimony between the Centre and the states have brought the Goods and Services Tax (GST) to a crossroads where while it has scope for rehabilitation, it also faces dangers of balkanization of Indian markets.

Issues with the GST regime

• Pre-COVID deficiencies: Centre committed the original sins:
  • In 2017-18, the Centre played fast and loose with the Integrated -GST settlement, delaying and reducing the amounts paid to the states.
  • In 2018, the Centre transferred the compensation cess to its own coffers, the Consolidated Fund of India, rather than to the compensation kitty.
• Impact of COVID: Covid-19 is a historically unprecedented economic shock, perhaps the greatest since the First War of Indian independence in 1857.
  • Fiscal revenues have been devastated; the money to pay out the guarantees is simply not there.
  • COVID is the sort of crisis which forces governments to throw the rule book out.
• Distrust between the Centre and States: Given that the states need revenue now, and given the Centre’s sins in the past few years, the states have reacted negatively to the Centre’s proposals.
• Technically Flawed Proposal: The recent proposal by the GST Council is flawed over the following points:
  • Given the large shortfall in GST collections, some government entity will need to borrow: the plan calls for this to be done by the less-able states, rather than the more-able Centre.
  • The proposal would add to the complexity of the GST by perpetuating cesses, far past the five-year terminal date, further complicating state fiscal responsibility budget targets.

Way Forward:

• Acting in Good Faith: Both sides (the Centre and the states) should exhibit a modicum of good faith.
  • The Centre should take the responsibility of borrowing for the states
  • States should act in good faith and not insist on demand of a 14% increase at a time when the revenue everywhere have declined by as much as 20%.
• Negotiate a one-off political agreement: In light of COVID emergency, the solution cannot be legal-cum-technical, stemming from the letter of the law. Following steps can be taken
  • For fiscal 2020-21, the states would receive a compensation of X%, where X is somewhere in between –Y% (the expected shortfall in GST revenues) and 14%. X can be -
    • The same level of compensation as last year;
    • Equal to the average of –Y% and 14%; or
    • Sufficient to ensure that state GST receipts are the same as last year.
  • For 2021-22, the Centre should commit to going back to the 14% commitment, recognizing that this is the last year of the compensation window.
  • The Centre, not the states, should secure the needed amounts through borrowing in financial markets.
  • It is the top political leaders, not attorney generals or bureaucrats, who should be sitting together and settling this thorny issue of compensation.

Conclusion: Political negotiation must find the way through cooperative federalism, otherwise potentially still path-breaking, tax reforms of the last 20 years could rapidly come undone.