At a time when it is important to try and stimulate the contracting economy, even if the states were to agree to raise rates on zero-duty goods or on those with low rates, this would hurt consumption; so while there may be a case to raise rates on certain goods, this is the wrong time for it.
While the Centre and the states battle it out over GST compensation, it is important to note that both have a valid point; at the same time, both are being stubborn and economical with the truth. Certainly, the state governments are right when they say that the Constitutional amendment had clearly said the Centre would guarantee the states a 14% annual increase in revenues; to the extent, there is any shortfall—as there is now—as West Bengal finance minister Amit Mitra said in his letter to the Union finance minister Nirmala Sitharaman, the Centre has a constitutional and moral obligation to make good the amount. But, as the central government has been pointing out, the constitutional position is that this money has to be paid out of the GST compensation cess; to the extent, there is no money in the fund, there cannot be any compensation, and there is no question of the Centre dipping into its own funds to make the payment.
The central government is also right in arguing that, were the states to agree to remove some items from the exempt list and to raise the duties on items that are taxed at very low rates, this would raise the level of monthly collections; as an aside, it would also help India move towards a single GST rate which, in itself, is a desirable goal as it will eliminate a lot of the problems that the GST system faces today. Also, while it is true, the Centre had agreed to compensate states—for five years—in such a manner that their post-GST revenues rise by 14% annually, this was done when the overall economy was projected to grow at much higher rates than today’s; with GDP growth slowing dramatically, it makes sense for the states to agree to a lower growth number since, had GST not been implemented, their revenues would not have grown by 14% a year.
But, and here’s the problem, at a time when it is important to try and stimulate the contracting economy, even if the states were to agree to raise rates on zero-duty goods or on those with low rates, this would hurt consumption; so while there may be a case to raise rates on certain goods, this is the wrong time for it. And it cannot help that, over time, the central government has been increasing the number of goods on which it levies a cess instead of a tax; under the law, a tax has to be shared with the states while a cess does not.
While cesses were 4.7% of the Centre’s non-GST tax revenues in FY19, they are projected to rise to 8.2% in FY21; with most tax collections likely to grow slower than projected, this number may even rise further. So, apart from the fact that a contracting economic growth will ensure state revenues collapse, the cess reduces the states’ taxes even further. The most important lesson the Centre needs to keep in mind is that, if states fall short of funds, they will spend less and this will, in turn, hurt overall economic growth; that will ensure that central revenues fall even more. While the immediate pandemic-driven crisis may get resolved with the central proposal to speak to RBI about raising borrowing limits for states—and to help them borrow at near-GSec rates—the Centre needs to examine the possibility of borrowing more on its own, if need be, to compensate states provided they are more reasonable and accept a revenue growth that is substantially below 14%.