Interstate movement of goods was troublesome before the implementation of Goods and Services Tax (GST). Every state used to classify goods according to its understanding and collected Sales Tax at different rates. For example, kraft paper could be classified as “packing material” and taxed at 20 percent one state, while it could be classified as “paper” in another state and taxed at 25 percent. These variations led to a number of disputes at the borders and hampered interstate trade. The Union Government implemented a GST system which classified all goods in the same category and imposed the same rate of tax across the country. The businesspersons no longer had to calculate the different rates of Sales Tax applicable in different states while making a sale. The businessperson in Mumbai today does not have to calculate the different rates of GST on the same goods sold to Cuttack and Delhi.
However, the states were not willing to give up their autonomous power to levy Sales Tax as per their requirements. In order to overcome their resistance, the Union Government assured them that it will compensate them for any shortfall in GST during the next five years. This compensation was to be calculated assuming a 14 percent increase in GST per year. The present problem is that the economy has been slowing for the last four years since the implementation of GST thus the collections are less while the Union Government is committed to compensate the states at the rate of 14 percent increase. The Covid Pandemic has pushed the matter to the brink. The Union Government is unable to compensate the states as they were promised. A huge amount of Rs 2.35 lakh crore has become due to the states. The Union Government has made a scheme that it will borrow Rs 1.1 lakh crore and pass on the loan to the states to help them meet their expenses during the delayed payment of compensation. However, the states will have to bear the interest burden on this loan.
This GST system has taken away the autonomy of the states. Previously every state had the authority to change the rate of Sales Tax. For example, Himanchal could collect higher rates on room heaters and Tamil Nadu on air conditioners which are bought more in the two States respectively. In consequence the states are caught in a bind. They cannot increase the GST rates in case they want to raise money, for example, to make a highway or a Metro. The situation will become catastrophic for a number of States after the end of the five years when the Union Government’s assurance to compensate for loss of revenue will come to an end. Reportedly some states will see a sudden decline in their revenues by up to 40 percent. They will not be able to even pay the salaries of their police and revenue personnel. The entire law and order situation in these states can crumble.
We should consider giving autonomy to the States to fix the rates of GST. A number of large countries provide such an autonomy. Canada, for example, has three types of GST. Only 5 percent “Federal” GST is collected on goods sold in Alberta. Five percent “Federal” GST and 7 percent Provincial states Tax (PST) is collected in British Columbia. The two taxes are combined and a 13 percent Harmonized Sales Tax (HST) is collected in Ontario which includes a 5 percent share of the Federal Government. The movement of goods from one state to another remains seamless despite this multiplicity of GST rates. There are no border checks. The seller collects GST as applicable in the state of the buyer. For example, seller “A” in Alberta will collect only 5 percent “Federal” GST on goods sold to a buyer within the state. The same seller “A” in Alberta will collect 5 percent “Federal” GST and 7 percent PST, total 12 percent, on goods sold to a buyer “B” in British Columbia. Now, let us say, the buyer “B” in British Columbia sells those goods to a buyer “C” in Ontario. In this situation “B” will take setoff of 12 percent GST (5 percent “Federal” GST and 7 percent PST) and collect 13 percent HST from the buyer “C” in Ontario. All the taxes—GST, PST and HST—are collected by the Federal Government and then distributed to the States on the basis of the bills raised.
We can modify the present GST into such a system. A seller “X” in Maharashtra may collect 18 percent GST on goods sold to a buyer within the state if Maharashtra does not impose a PST. The same seller “X” in Maharashtra will collect 18 percent GST and, say, 2 percent PST, total 20 percent, on goods sold to a buyer “Y” in Andhra Pradesh if Andhra has a 2 percent PST. Now, let us say, the buyer “Y” in Andhra Pradesh sells those goods to a buyer “Z” in Odisha. In this situation “Y” will take setoff of 20 percent GST (18 percent GST and 2 percent PST) and collect 18 percent GST and 7 percent PST, total 25 percent from the buyer “Z” in Odisha if the PST in Odisha is 7 percent. Such a system will restore the autonomy of the states to impose addition PST as per their requirement. At the end of 5 years, Punjab can impose a, say, 5 percent PST and save itself from bankruptcy.
Canada has gone beyond GST and provided autonomy to the states to levy Provincial Income Tax. The Federal Government collects Federal Income Tax @15 percent on taxable income up to 49,000 Canadian Dollars. A taxpayer in Alberta pays an additional 10 percent Provincial Income Tax on taxable income of 131,000 Dollars, one in British Columbia pays an additional 5 percent Provincial Income Tax on taxable income of 42,000 Dollars and one in Ontario pays an additional 5 percent Provincial Income Tax on taxable income of 45,000 Dollars. Every state in Canada has autonomy to collect both GST and Income Tax as per its requirement. A similar system is in place in the United States of America. I know of a person who has changed her domicile from New Jersey to Florida to take advantage of lower rates of Provincial Income Tax in that State.
We must soon provide a similar autonomy to our States. This will eliminate the pressure on the Union Government to continue compensating the States for shortfall in GST beyond the five years committed earlier. It will restore the ability of the states to raise revenues to make water recharging structures, highways and metros. It will save the unity of the country that is being threatened due to the states being bound with lower revenues and higher expenses.
(The author is formerly Professor of Economics at IIM Bengaluru)