After Centre’s Rejig, GST will be Manna from Heaven for States


The Centre has finally worked out a compromise formula on GST

  • GST is a destination-based consumption tax; states where the final consumer is based will get all taxes on a particular product or service
  • States to be compensated up to 100% for all five years
  • 1% additional tax is origin-based; may distort GST
  • States insisted on the 1% additional tax so that delay in transfer or procession by Centre does not hamper how their governments are run
  • Revenue shortfall in first five years to be compensated by Centre, thus the 1% additional tax may be a revenue source

Many states look set for a tax revenue bonanza in the initial years of the implementation of the goods and services tax (GST), as opposed to a decline, with the Centre agreeing to not only compensate states fully for a shortfall in revenue for the first five years but also allow them to charge up to 1% additional tax for at least two years on all goods produced in their territory but sold in another.

Tax practitioners and businesses had suspected that the 1% additional tax was meant to be a new revenue source for states, and not just a measure to cover shortfall in revenue arising from implementing GST when the Centre agreed to such a tax on the demand of some states. Their suspicion is turning out to be correct. It may be recalled that the Centre had agreed to allow states to levy this 1% tax last November as a “compromise formula” to bring on board dissenters such as Gujarat for nation-wide rollout of GST.

The compromise formula was agreed to when the Centre was committed to compensating for revenue shortfall fully in the first three years of the GST rollout. In the fourth year, states were to be compensated to the extent of 75% of their revenue shortfall and in the fifth year to the extent of 50%. However, this July, the Centre agreed to change the compensation formula on a Rajya Sabha select committee recommendation to compensate states to the extent of 100% for all five years.

“States’ Concerns Justified”

States mostly on board with the Centre’s new formula (Photo: Reuters)
States mostly on board with the Centre’s new formula (Photo: Reuters)

Asked by industry about the need to allow states to charge 1% tax when they are to be fully compensated for revenue losses for the first five years of GST regime, Revenue Secretary Shaktikanta Das said states did not want their spending plans and administration to be dependent on the flow of compensation money from the Centre. Their concerns are justified, Das said at an interactive session organised in Delhi by Assocham recently.

Das added that while states are happy with the compensation mechanism, the developed ones, in particular, did not want to be dependent on that compensation and wanted flexibility on raising revenue. States fear that delays in processing and transferring compensation by the Centre could hamper how their governments are run.

It is generally believed that states with a high manufacturing base would be the ones that would benefit from the 1% tax. But that is not a correct interpretation. Punjab, Haryana and Uttar Pradesh, which serve as India’s grain bowl, too will gain – all foodgrain grown there but sold outside would also attract the 1% tax. Likewise, Odisha and Jharkhand with their mineral resources would gain, as well, when minerals mined in these states are sold to buyers in another state.

What States Fear

States’ revenue shortfall in first five years to be compensated by the Centre (Photo: Reuters)
States’ revenue shortfall in first five years to be compensated by the Centre (Photo: Reuters)

So why would states face shortfall in revenue when GST is rolled out? The fear arises from the nature of the tax. GST is a destination-based consumption tax, meaning the state where the final consumer is based will get all taxes on that specific product or service. The existing system of taxation at the state level, in contrast, is mostly origin-based, meaning the tax is collected at the place of manufacturing.

States such as Gujarat fear that GST’s implementation will lead to erosion of their tax base while those such as West Bengal that do not have as much manufacturing would gain. The 1% additional tax is also an origin-based tax and it would distort GST. For industry, the 1% tax increases cost because they cannot set it off against other tax dues, and for consumers, who will ultimately bear it, it may increase the cost of a product.

Misplaced Apprehensions

The fears of revenue loss under GST by states such as Gujarat is mostly misplaced. While their concerns about revenue outflow is fair, it is also a fact people in developed states are wealthier and therefore have higher purchasing power. In all likelihood what states such as Gujarat would lose on account of outflow of goods, they are likely to gain with inflow of goods for consumption.

That apart, all states are also allowed to tax services. Any shortfall in the first five years will be compensated by the Centre and therefore the 1% tax may turn out to be a revenue source. What needs to be seen is will states charge this 1% for only two years or want it to continue for many years.

(The writer is a Delhi-based senior journalist)


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