Front-loading tax devolution: Centre does its bit, over to the states now

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November 22, 2021 4:00 AM

Higher than budgeted devolution of taxes to the states more than makes up for fuel-levy cuts

The revenue loss to the Centre, for the remaining part of the fiscal, is pegged at Rs 44,000 crore.The revenue loss to the Centre, for the remaining part of the fiscal, is pegged at Rs 44,000 crore.

Finance minister Nirmala Sitharaman has exhorted India Inc to take on more risk, and has promised to go the extra mile if companies commit to more investments. Indeed, the Centre seems determined to get growth going; besides calling on banks to disburse more loans, the FM also incentivised the states to spend more. Tax devolution has been front-loaded to help them step up their pace of investments; Rs 95,000 crore is to be released this week rather than half that amount as per the Union budget. This is more than a welcome move; there is little point in holding back funds. Typically, the tax devolution to states is done in 14 installments in a year, and adjustments, as per revised estimates, are usually done in March. If the monthly amount of devolution of Rs 47,500 core is retained for December-February in FY22, this would imply a lower back-ended devolution for March 2022, allowing states to spend more.

Tax transfers have been advanced thanks to robust growth in collections, expected to top budget estimates by Rs 2 lakh crore. In the first seven months of FY22, gross indirect tax collections—net of refunds but before devolution to states—rose by 51% year-on-year, to Rs 7.4 lakh crore, against a required rate of 3% to hit the full-year target of Rs 11.09 lakh crore. Direct tax collections, too, increased by 70%, to Rs 6.45 lakh crore. The GST collections, too, have been good. To improve the liquidity of states, the entire back-to-back loan component of Rs 1.59 lakh crore has been released in lieu of shortfall in release of GST compensation during the current fiscal. This is in addition to the compensation released to the states from the designated cess kitty of Rs 60,000 crore. These good tidings on tax buoyancy have also prompted the government to cut fuel taxes on petrol and diesel after stonewalling for a long time (and even raising them further). The official stance ranged from the cost of servicing legacy oil bonds and to asking the states to do so. As FE has shown, the first factor was not a serious consideration as the cost was estimated at barely 10% of the Centre’s extra revenue from fuel taxes. The states, especially those that have administrations opposed to the ruling BJP-led government, are naturally upset at being asked to lower taxes. The Centre reduced the road and infrastructure cess component of central excise duty by Rs 5 per litre motor spirit and Rs 10 per litre on diesel.

The revenue loss to the Centre, for the remaining part of the fiscal, is pegged at Rs 44,000 crore. Since most states levy an ad valorem VAT, this will reduce their inflows by Rs 9,000 crore. The revenue loss from VAT cuts announced by 25 states has been pegged at Rs 35,000 crore. Their revenue foregone thus is similar to the Centre’s, according to ICRA chief economist Aditi Nayar.

States may allege a dilution of the spirit of federalism, but their loss from the fuel tax cut may be more than outweighed by bullish tax collections and higher devolution than budgeted. They must not complain. They have been bailed out, on more than one occasion, for their large discom losses; the latest package ran in some Rs 90,000-crore-plus, but despite this, the financial health of most discoms remains poor. Moreover, the Centre has enabled higher market borrowings for states. With the 14% guarantee for GST revenue shortfalls unlikely to be extended post June 2022, states must up their game. The compensation clause was intended as a hand-holding measure, but, now that the economy is reviving, states must manage their finances.

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