Taxing times for India’s cooperative federalism

India Federalism

Far from bringing out the best in people and institutions, a crisis can bring out the worst too. That is precisely what seems to have happened, in the wake of the Covid-19 pandemic, to the concept of ‘cooperative federalism’ between the central and state governments, claimed as one of his key policies by Prime Minister Narendra Modi.

Since the beginning of 2020, there have been several assaults on the country’s federal traditions and processes. These include the arbitrary imposition of a total lockdown in April last year  without consultation, the centre’s refusal initially to bear the full cost of vaccination, and its denial of adequate funds to the states in a timely manner for Covid-19 relief.

However, the Modi Government’s reneging on agreements with state governments for  the sharing of national tax revenues takes the cake in this regard.

To give some background, many state governments were reluctant for long  to accept the proposal for converging all taxes levied by the Central or State Government on the supply of goods or services in the country.  Called the Goods and Services Tax (GST), it was to be levied on supply of goods or services or both at each stage of the supply chain starting from manufacture or import and till the last retail level.

COVID Response Watch LogoFor state governments it meant giving up their right to impose indirect taxes and also a potential  loss of revenues. They however finally agreed to accept the new GST regime in mid-2017, based on  the promise of compensation for any revenue loss, made by the then NDA Finance Minister Arun Jaitley. The funds for compensation would be raised through a cess levied on a few items such as automobiles, cigarettes, and aerated drinks and paid to States for five years until June 2022.

It is precisely this promise that has been broken during the pandemic period last year by the central government, at a time when state governments need the money urgently to tackle the pandemic.  Claiming a fall in GST revenues due to the Covid-induced economic downturn it has  stalled transfer of the full amount of the agreed upon compensation to the States.

Total GST collections were sharply reduced in 2020, with its prolonged lockdowns and closure of businesses. GST payment deadlines have also had to be deferred and GST dues allowed to spill over to the next fiscal year.

The GST Council – set up to regulate or direct GST implementation and headed by the Finance Minister –  has estimated the shortfall in compensation at Rs.2.35 lakh crore. State governments have however claimed that the total  compensation due to them is in over Rs 3.23 lakh crores.

The brazen way in which the Centre has gone back on its word to make up for revenue losses due to GST implementation is seen even by many as a setback for principles of federalism in the country.

Speaking to Covid Response Watch, D. Jayakumar,  finance minister in the former AIADMK government in Tamil Nadu, said that despite being an ally of the BJP, his party upheld the State’s rights on federal issues.

“Even when the Centre switched over from sales tax to value-added tax (VAT), Amma (former Tamil Nadu Chief Minister J.Jayalalithaa) insisted that there should be 14% compensation to States as it was a losing proposition for Tamil Nadu and agreed to it only after the UPA Government at the Centre also agreed to provide compensation. In the same spirit, we also insisted on compensation on transition to GST, not just for five years but indefinitely, and for the pandemic year too” he said.

Yet another contentious issue that cropped up between the States and the Centre during the pandemic period was the demand from States to totally remove GST imposed on Covid-19 vaccines, oxygen, drugs, and other essential items such as personal protection equipment.

After the vaccination drive for the general public began in March 2021 representatives of the States raised this issue with Nirmala Sitharaman, who headed the GST Council. The Finance Minister however  referred the matter to a committee, with a majority of BJP controlled state government representatives, which recommended only partial reduction in GST on vaccines and other Covid-19 goods. It seemed as if Ms. Sitharaman was more concerned about her coffers than the lives of poor people, suffering due to highly inflated black market prices of Covid-19-related items.

The Modi government’s anti-federalist spirit has continued in Financial Year 2021-22 as well, evident from the way it continues with reduced devolution of funds to the states despite a recovery in the economy. The 15th finance commission  fixed the transfer to states from the divisible tax pool to 41 per cent for 2021-22 to 2025-26.

After lifting of the lockdown in July 2020 recovery in GST picked up pace from  September 2020 itself.  In fact, the GST recovery was much better than the recovery in GDP growth in the first quarter of the current financial year FY 2021–22 as could be seen from the monthly figures of Index of Industrial Production. The number of GST returns filed per month has also caught up with previous peak levels after the unlocking in many States after the 2021 Covid-19 second wave.

The Centre too had decided to waive the Fiscal Responsibility and Budget Management Act (FRBM Act) for the crisis year of 2020–21, thus lifting the ceiling on fiscal deficits and the total borrowings by the Centre and the States. It could have and positioned itself  to go on a borrowing spree and raise the funds needed by the States.

However, the Centre has refused to avail of this opportunity, when it could have borrowed more and met the devolution targets. Instead the devolution of funds from the Centre to the States came down to the tune of Rs.8600 crore per month in April & May 2021.

Talking to Covid Response Watch in this context, Professor Constantine Ravindran, the official media liaison in-charge of the MK Stalin-led DMK government in Tamil Nadu, said: “If the reduction in devolution from the Centre to the States to the tune of Rs.8600 crore each in April and May continues at the same rate for the whole fiscal year, States would lose upwards of Rs.1 lakh crore. The budgeted amount of transfers to States would have to be drastically revised downwards. This is a huge fiscal blow to the States. 80% of the expenditure of the States is committed expenditure like salaries. States will have to borrow more, pay more interest in the coming days and development would take a blow. In the ultimate analysis, this would bring down total GST collection and Centre’s revenue as well. Modi Government is committing harakiri through its federal assaults”.

Regarding the attitude of the Modi Government on federal issues in general, Prof. Ravindran further added, “The BJP Government has trampled upon the rights of the States and forced the States to now cringe for funds with a begging bowl. Take the case of tax on petrol and diesel. The BJP government has converted the earlier tax to the tune of Rs.32 per litre into cess and unlike the tax the cess is not devolved to the States. The States are thus deprived. The DMK is demanding that petrol & diesel should be brought under the GST regime abolishing the present cess. Price of petrol can then come down to around Rs.60–65 per litre even if they levy GST at the maximum rate band of 18%. That apart, States like Tamil Nadu, in which transport sector’s share is very high in gross state domestic product (GSDP), would get an economic boost. Just because our DMK State Finance Minister Palanivel Thiagarajan demanded this in the GST Council, his name was not included in the committee to suggest amendments to the GST law. This shows the cooperative federalism hype of PM Modi in its true colours.”

Prof.Constantine Ravindran is right. Jumlas cannot be sustained for long!

S.Sundaram is a political commentator

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