Reform GST Council - Don’t throw the baby out with the bath water | Atul Sarma and Shyam Sunder

by Atul Sarma and Shyam Sunder *

The Supreme Court (SC) order on GST Council recommendations in (Union of India and ANR versus M/S Mohit Minerals) on May 19, 2022, held:

“The ’recommendations’ of the GST Council are the product of a collaborative dialogue involving the Union and States. They are recommendatory in nature. To regard them as binding edicts would disrupt fiscal federalism, where both the Union and the States are conferred equal power to legislate on GST”.

The SC ruling can be seen as a mere “reiteration of the constitutional provision-there is nothing in constitutional amendments relating to GST to force compliance with GST Council decisions” (D. Subbarao, TOI, May 31, 2022). Yet this SC order could have huge implications on the operation of goods and service tax and could even undo what was achieved through a long process of negotiations. It has come at a time when the cushion of GoI’s compensation to states for deemed shortfalls in GST collection which was for a period of five years since its introduction would come to an end on July 01, 2022. States’ particularly the ones being ruled by opposition parties, disputes with the centre could mount.

Indian federation politically integrated the states and other polities but not economically. States with varying economic level and structure levied constitutionally assigned taxes. With direct taxes being fewer, states levied multiple indirect taxes, apart from mobilising revenue, to sub serve other development objectives. In the process the national economy became fragmented. From an economic perspective, a federation has an inherent advantage of unifying the economy by way of creating a single market where goods, labour, capital and entrepreneurs move freely from one part to another without encountering any barriers.

Sales tax and other indirect taxes not only impeded free movement of goods across the country but also led to price cascading-taxing inputs to produce an output which is again taxed, i.e., tax on tax. It was hugely distortionary. Again, in a country with uneven level of development, tax competition and exporting became common features. It is in this context, an exploration began to replace multiple indirect taxes by a single tax in the form of goods and services tax (GST) for the entire economy. It took long sixteen years of negotiation and consultation to implement this tax in 2017. This was a momentous tax reform that facilitated one nation, one tax. This was also an exemplary stride in cooperative federalism.

Recalling briefly the arduous and complex process of consultation and negotiation with the stakeholders - the Centre, 29 States and 7 Union Territories - that has made this game-changing outcome of GST possible should convince why the SC ruling must not be resorted to, to undo this huge achievement.

In view of their drawbacks, indirect taxes witnessed several changes. The Central government introduced in 1986 Modified Value Added Tax (MODVAT) covering a few manufacturing goods providing credit of excise duty paid on inputs and later extended as Central Value Added Tax (CENVAT) over the years to cover other commodities and services. Following the recommendation of a uniform model of VAT by the Tax Reform Committee (RJ Cheliah, 1992), in the Union Finance Minister convened meeting, Chief Ministers agreed to implement a uniform floor rates through harmonising rates of sales tax from January 1, 2000 and introduce State-level VAT. An empowered committee of State Finance Ministers with West Bengal Finance Minister, Asim Dasgupta as chairperson was set up in 1999 to work out the modalities of VAT. Eventually, most states implemented VAT with effect from April1, 2005.

VAT was a significant improvement over the sales tax regime. However, it does not eliminate tax cascading altogether. For example, VAT on sale does not eliminate from the cost of a good the excise component embedded. Nor set off is provided against Central Sales Tax, resulting in VAT taxing also the excise component. This distorts the price of a good leading to misallocation of resources which eventually lower efficiency and growth. The Goods and Services Tax (GST) eliminates these shortcomings.

GST is a consumption tax based on the credit invoice method. With input tax credit along the supply chain, only the value addition at each stage is taxed, it subsumed in its ambit most of the previously levied central and state consumption taxes while the Central Sales tax being an origin-based tax is abolished. All this results in a greatly rationalized taxation structure.

Its base covers all goods and services with limited exemptions. Cascading gets automatically eliminated. This should bring down prices and tax incidence to consumers. Lower prices induce higher consumption of goods and services as also makes the economy more competitive in global market thereby boosting export. GST being a consumption based tax should also fetch larger revenue.

However, in view of GST subsuming currently operational sixteen indirect taxes-seven central taxes and nine state taxes, negotiations were very challenging. More so, because, while bringing the current indirect taxes under GST, States’ contribution to the GST pool in terms of their current yields of the merged taxes, worked out at three-fourths while that of Centre’s at one-fourth. Sacrificing constitutionally assigned taxation power to this extent called for flexibility and accommodation both by the Centre and States. This process was long drawn as its brief history would highlight.

The Task Force on “Implementation of the Fiscal Responsibility and Budget Management Act, 2003” (chaired by Vijay Kelkar) argued for a comprehensive GST based on the VAT principle. Union Budget 2006-07 proposed to introduce a national level GST by April 1, 2010. The Empowered Committee (EC) of State Finance Ministers was assigned to prepare a design and roadmap for the implementation of GST. The EC submitted: “A Model and Roadmap for Goods and Services Tax (GST) in India” in April, 2008, and the first discussion paper on GST on November 10, 2009.

The Constitution (One Hundred and Fifteenth Amendment) Bill, 2011 which was introduced in the Lok Sabha to enable the levy of GST, lapsed with the dissolution of the 15th Lok Sabha. Later the Constitution (One Hundred and Twenty Second Amendment) Bill, which was introduced in the Lok Sabha in December 2014 culminating into an Act with effect from September 8, 2016.

Under Article 279A of the Constitution the GST Council together with GST Council Secretariat was constituted in September 2016. The GST Council is a joint forum with the Union Finance Minister as Chairperson and the Union Minister of State in-charge of Revenue, the Minister in-charge of finance or taxation or any other Minister nominated by each state government as Members. In the Council, state government representatives enjoy two-third voting share while the Centre remaining one-third. Decision is to be taken with a three-fourth majority.

The Council’s mandate comprises recommendations on (i) the goods and services that are subjected or exempted from GST; (ii) model GST Laws; (iii) principles that govern place of supply; (iv) threshold limits for exemptions;(iv) GST rates including the floor rates with bands; (v) special rates for raising additional resources during natural calamities/disasters; and (vi) special provisions for certain states.

Keeping in view India’s federal structure, GST has been implemented in dual structure- one Central Goods and Services Tax (CGST), State Goods and Services tax (SGST) including two Union Territories with legislatures, one Union Territory goods and services tax (UTGST) without legislature, and one Integrated Goods and Services tax (IGST) law governing inter-state supplies of goods and services.

Both the Centre and states simultaneously levy GST on the same base across the value chain on supply of goods and services. The Centre levies and collects CGST, while states do SGST on all transactions within their respective geographical jurisdictions. The input tax credit under the CGST and the SGST are available at each stage. The additional duty of excise/countervailing duty (CVD) and the special additional duty (SAD) levied on imports are merged into the GST.

The integrated goods and services tax (IGST) Act, 2017 applies to movements of goods and services from one state to another. It is not a separate tax but a sum of CGST and SGST. In all, five laws, viz. Central Goods and Services Tax Act, State Goods and Services Tax Acts, Integrated Goods and Services Tax Acts, Union Territory Goods and Services Tax Act and The Goods and Services Tax (Compensation to the States) Act-were enacted before India introduced the Goods and Services Tax (GST) on 1 July 2017 after a long process of consultation, negotiation and preparation.

This is in a nutshell the long chain of events leading to this historic tax reform in India. This is also a shining example of cooperative federalism at work. However, GST has been operating far below its potential largely because of its faulty design. An ideal GST should have one or two tax rates. Current five tax rates are far too many to have desired revenue and administrative efficiency. GST Council which is a great institutional innovation should make conscious efforts towards an ideal GST. GST Council also requires reforms towards as SC puts: “The GST Council is not merely a constitutional body restricted to the indirect tax system in India but is also an important focal point to foster federalism and democracy” and towards assigning voting rights in proportion to the Centre’s and States’ respective contribution to the GST pool.

By July 01, 2022, States would clamour for extending the period of compensation beyond the stipulated five years. In view of lower than expected revenue growth at one level and growing trust deficit resulting from the Central government’s partisan behavior on several occasions at the other, this clamour might assume a crescendo or some states might even draw inspiration from the SC ruling to act that might counter to the epoch-making reform. The way forward would be to set up a suitable dispute resolution mechanism as the GoI is rightly considering.

* (Authors: Atul Sarma (sarmaatul[at]yahoo.com) is Former Head and Professor of Economics, Indian Statistical Institute, Delhi Centre and Shyam Sunder (shyams.eco[at]gmail.com) is working with an Indian Corporate. Views are personal.)