Fix the GST

The tax requires a complete overhaul – and both the Centre and the states need to work together and make some concessions.

The Central Government’s decision to borrow Rs 1.1 lakh crore and then pass it on to states to make up for the shortfall in the GST compensation this year should help cool the rising tensions at the GST Council. The borrowing by the Centre will help ensure uniform and better rates than many states could have negotiated on their own. The debt will not reflect on the Centre’s books – it will show up in the balance sheets of the states. The debt will be serviced by extending the GST compensation cess collected, which will now carry on beyond 2020.

It is not a complete solution. The shortfall in the states’ share of GST this year is estimated at Rs 3 lakh crore. Of that amount, the Centre has so far promised to give Rs 65,000 crore as compensation  this year. Another Rs 1.1 lakh crore will now be borrowed by the Centre and passed on to states according to this plan. But after this, the states will still collectively be short of Rs 1.25 lakh crore – which they will have to raise on their own unless the Centre announces something new in the coming days.

The states that do not have a BJP government would still want the Centre to shoulder the burden of the borrowing on its books and to also introduce clarity on the remaining amount that is not covered by this plan. (Probably the BJP governed states would like that too though they will not say so publicly). Apart from this, the other issue that the states have with the Centre is that the latter is taking decisions and announcing the plans with without adequate discussion in the GST Council meeting.

The non-BJP led state governments will probably continue to object to the Centre’s highhandedness and may continue exploring legal recourse. But even they have to admit that COVID is a Black Swan event and that no one could have planned for. And given the state of the economy and the tax collections, there is simply not enough money for the Centre to fulfil its promise of 14% guaranteed increase this year, as it had committed at the time of passing the GST Act.

The Centre too needed to find a solution that is at least partially acceptable to the states. If it tries to play hardball, the already bruised economy would take an even greater knock. In many crucial areas like infrastructure, states spend far more than the centre. They also do the heavy lifting in healthcare, education and policing and are at the forefront of the COVID battle. As I have argued in another column, if the centre needs to fix the economy, it will need to mend its relationship with the state governments. (https://www.prosaicview.com/reach-out-to-the-states/)

But no matter how the final discussions on this issue between the Centre and states go, it is apparent that GST in India needs major overhaul – not minor tweaking. Both the Centre and the states need to understand this. After three years of its implementation, few of the promised benefits of GST have accrued to the economy. As studies in other countries show, GST can either help the economy and tax collections – or it can set the country back. Much depends on the design and implementation. And as many people have pointed out the Indian GST was badly designed – and has been terribly implemented.

In order to get the states to sign off on the GST, the Centre agreed to a highly convoluted tax structure with multiple rates and cesses that made a mockery of the promise of simplification. The complicated filing requirements only added to the problems. The promise of boosting the economic growth by 1-1.5% after implementation of GST has also proved to be a Chimera. Instead, evidence is piling up that GST has caused endless problems for small and medium enterprises, and especially those of the smaller enterprises involved in exports. It has, in fact, played a big role in the slowing down of the economy prior to COVID, instead of helping boost growth. As a consequence, the revenue collections of the government has also been hit – the tax to GDP ratio has fallen sharply

The Centre and the states – the GST Council in fact – needs to go back to the first principles of the GST. What was the original purpose? To simplify the plethora of taxes at Central and state levels that made business so difficult and led to so many disputes. What would be achieved by replacing those taxes to a simpler, all-India, highly transparent tax system? It would benefit businesses by simplifying their life and boost the economy – and improve tax collections. The Centre would do the collection, but it would be shared properly with the states in time and in the right proportions as agreed upon.

Some initial hiccups were anticipated. A major change always takes time to settle. But these were supposed to be temporary. After three years though, it is apparent that the Indian version of GST is a work in progress with the destination nowhere in sight.

Before COVID struck, the calls for GST 2.0 – a comprehensive overhaul of the flawed version that has been implemented – was becoming louder. The current crisis only makes it imperative that the Centre and the states sit down to do so urgently. It will require both the centre and the states to take a step back and offer concessions. But it will help everyone, the economy, and the cause of federalism, in the long run.