Uncooperative Federalism

Context: ‘One state one vote’ under GST is distortionary. Case of taxes on Covid products is stark illustration.

Issues with the GST:

• Distorted design and incentive structure:
  • There is a large imbalance in the collection and distribution of taxes between states, and this holds true also for income accrued to and distributed from the GST pool.
  • Four states — Maharashtra, Tamil Nadu, Karnataka, and Gujarat contribute nearly as much (~45 per cent) as the remaining 27 states combined.
  • Only about 30% of the overall revenue of the states mentioned above comes from the Union government.
  • But for the remaining 27 states, roughly 60% of their revenues are obtained through transfers from the Union government.
  • While in almost every federal Union, net-transfers work to reduce differences in development between states over time, reducing the quantum of net-transfer in the future as states become more equal through such transfers, but in India, the opposite has occurred.
• Diversion of money to the states: The Union has shifted a large proportion of taxation (roughly 18 per cent of its overall revenues) into cesses, a special form of taxes that remain outside the GST pool and hence do not have to be shared with the states.
  • This is an affront to fiscal federalism and an assault on “cooperative federalism”.
• ‘One state one vote’ does grave injustice: States that are more dependent on transfers from the Union want to maximise GST collections while states that are less dependent can afford to be more sensitive to citizens’ concerns.
  • Thus, while the states like Maharashtra can easily forgo taxes over vaccines but the smaller states, those who are dependent on the Centre for net transfer, would want to increase GST collection.

Way Forward:

• Proportional representation in the GST Council: Had there been a proportional representation of voting in the GST Council either as a proportion of the size of a state or by its contribution to the GST revenue pool, Covid products would have been tax-free by now.
  • Just as the direct tax policy decisions are legislated by Parliament, which has proportional representation from states, indirect tax policy decisions should not be subject to a “one-state one vote” formula.