How You’ve Grown
The kitty that will be available for transfers to states will depend on the assumptions underlying GDP growth, and revenue and expenditure projections for the next fiscal. But forecasting poses a challenge in a slowing economy. Tax collections have dented, as the nominal GDP growth rate at 6.1% in the July-September quarter stood at about half the anticipated growth rate in the Budget.
With India adopting the goods and services tax (GST), historical trends in revenue collections have ceased to be relevant to forecast future revenues, according to a National Institute of Public Finance and Policy (NIPFP) study, ‘Fiscal Implications of Introduction of Goods and Services Tax in India’ by Sacchidananda Mukherjee and R Kavita Rao. The study, commissioned by the 15th Finance Commission, uses data from three sources that are not comparable to estimate GST revenues. The entire exercise shows how complex it is to construct a consistent and a comprehensive data set on GST revenues.
Of the total GST collections, a lion’s share goes to states. Reportedly, actual transfers of the Centre’s gross tax collections are about 36% (below the 14th Finance Commission’s mandate to devolve 42%) since the divisible pool of taxes excludes surcharges and cesses. So, a fall in the Centre’s tax collections, even without a decline in the states’ own tax collections, could hurt state finances. There are concerns over delays in the Centre’s compensation to states due to the transition to GST. Given that states account for about 58% of the total government expenditure, the Centre should release the money even if that means borrowing more and widening the fiscal deficit. That is needed to spur demand.
Many states want a further extension of the 2022 deadline. Without a doubt, the Finance Commission must have a clear idea of the future roadmap on compensation to make credible projections on the likely revenues for states. There have been chop and changes in policy after GST rollout.
At the recent LK Jha memorial lecture, 15th Finance Commission chairman NK Singh underscored the need for symmetry in the working of the GST Council and the Finance Commission. This makes sense. He said the Finance Commissions look at projections of expenditure and revenue, but issues such as GST rates exemptions, changes and implementation of the indirect taxes are entirely within the domain of the GST Council. “This leads to unsettled questions on the ways to monitor, scrutinise and optimise revenue outcomes. Since both the Finance Commission and the GST Council are constitutional bodies, the coordination mechanism between the two is now an inescapable necessity,” he said.
Build the Right Chain
Singh also urged the GST Council to review its tax design and decision-making, saying that states have complained to the Finance Commission about their autonomy becoming constrained. The council must focus on systemic reform of the tax. It should broaden the tax base, bringing petroleum products, natural gas and electricity, besides real estate, under GST. This will complete the credit chain. Data analytics must be deployed to follow up the audit trail by GST and physical volumes of industry output. If a certain quantity of steel is produced and the final taxed steel goods add up to a lower volume, it would suggest leakage. The effort must be to plug the leakage. Polyester fibre is made by a few producers, and Surat is reported to have learnt to circumvent GST. This means a large volume of polyester fibre sold gets converted into yarn and fabric, and later garments, without paying tax. So, the need is to follow the volume trail to find out where the leak occurs.
Ideally, two GST rates and a simpler structure will benefit consumers. The NIPFP study says there is scope for improvement in compliance in the GST regime. Extensive use of the ‘reverse-charge’ mechanism on all large buyers – so that they collect the tax on their input purchases, leaving small suppliers only with filing of returns – would simplify things.
A stable final GST structure will ensure sustained increase in revenues, yielding a bounty in the medium term. So, providing a roadmap to the Finance Commission is a good idea. The same logic holds for customs duties too. GoI has raised duties on many products to ostensibly promote ‘Make in India’. The goal must be to lower the peak and average tariffs to, say, 5%, converging them on everything. Again, a roadmap would be useful to the Finance Commission to make forecasts.
India cannot afford to continue with a tax-to-GDP ratio of 17%. It must be at least doubled to enable GoI to raise capital spending and boost transfers to states.