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Tuesday, March 2, 2021

Why amicable resolution to GST shortfall is vital for our federal polity

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The dispute between the Centre and the states over making good the shortfall in the states’ collection of revenue from the goods and services tax (GST) should be resolved, for harmonious relations between the Centre and the states.

The only sensible way to resolve it is by the Centre borrowing the entire amount of the deficit and making good on its promise, made at the time of transiting to the new value-added tax that sought to subsume most pre- existing indirect taxes, and written into the Constitution amendment that gave states the power to tax services and the Centre to tax retail sales, necessary to operationalise GST.

Parliament passed a law, specifically on the subject of compensating the states for any shortfall in GST collections from a linear projection of 14% annual increase over 2017-22. This was not particularly well-conceived, in the sense an eventuality such as a major economic crisis that could derail growth and revenue projections was not taken into account at all. In any case, that was the promise made by the Centre and enacted in law.

The law also identified a cess on so-called sin goods as a source of revenue for compensating the states. However, nowhere did the law say that such compensation would be made only from the proceeds of the cess. In fact, at one point, the Centre did tap funds from the green cess on coal to compensate the states, establishing the principle that sources other than the cess on GST on sin goods can be used for compensating the states for GST shortfall.

Therefore, for the Centre now to take the position that the states should borrow to find resources for compensation is doubly untenable. In the first place, the very term compensation implies a combination of injury, some- one or something that has sustained the injury and a third party responsible for the injury and therefore obliged to pay out the compensation.

The suggestion that the injured party should compensate itself is absurd. It may be asked, doesn’t this notion of whoever causing the damage paying compensation wobble when the state compensates some victims of accidents or natural calamities? The state is responsible for governance, organising the conduct of citizens’ life and their security and so when citizens suffer some unforeseen misfortune, the state offers assistance both as a measure of welfare and as compensation for its failure to have averted that misfortune as part of its governance responsibility.

In either case, the injured party does not compensate itself. And it is precisely this absurdity that the central government has suggested, saying that the states should compensate themselves by borrowing.

Macroeconomic Stress

From the point of view of macroeconomic stress, what counts is the combined borrowing of the Centre, the states and other public sector entities, what economists call the public sector borrowing requirement. PSBR competes with private investors for available savings and can create excess demand, show- ing up as higher interest rates, inflation and a wider current account deficit.

In the present case, the demand for credit from the private sector is extremely weak, so PSBR is not going to create any kind of crowding out of private investment. Whether the borrowing is done by the Centre or by the states is of no consequence for macroeconomic stress and the rating agencies that try to smell out such stress. The Centre’s attempt to shove the compensation borrowing on to the states will actually end up in- creasing the PSBR in the coming years: the interest rate on state borrowings is higher than on central borrowing, and the states would have to borrow more in the future to service their loans to compensate themselves for the GST shortfall this year.

This would be irrational. What would happen if the Centre delays compensating the states for their GST shortfall? The states would not be able to meet their normal spending requirements. And that would crimp expenditure in the economy as a whole. In to- day’s India, the states together spend more than the Centre does, accounting for nearly 60% of the combined expenditure of the Centre and the states.

At a time when private consumption is constrained by uncertainty over jobs, private in- vestment is scarce, given low levels of capacity utilisation, curtailed state expenditure would further squeeze economic activity. The Centre’s reluctance to make good the states’ shortfall in GST collections is bad for federal ties and for economic growth.

The states and the Centre should go beyond fighting over compensation and complete the GST chain, covering exempt sectors such as petrofuels, alcohol, electricity and real estate. That would make audit trails more comprehensive. Make the mechanism of reverse charge universal whenever a small supplier makes a sale to a large buyer (under reverse charge, the buyer pays the tax due on the purchase directly to the government, instead of paying it to the seller and expecting the seller to pay it to the government and do the paperwork so that the buyer can take input tax credit for the tax so paid).

This would bring a large part of the informal sector of small suppliers also into the formal value added chain. Following up on GST audit trails can lead not just to higher collections under GST but also to greater realisation of direct taxes, increasing the fiscal capacity of the nation at all levels. The Centre and the states should spend their considerable energy on such productive reform of the tax system, not on dodging responsibility and trying to shift the blame. Discord is not an- other name for cooperative federalism.

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