The ongoing wrangling over the Goods and Services Tax (GST) exemplifies the fragile and complex federal relationship between the centre and states in India, and its resistance to any changes that could tilt the scales in favour of either side.
Various calculations have shown that introducing such a tax in India is likely to boost GDP by bringing in efficiencies. Despite its indubitable benefits, this comprehensive indirect tax law has been in abeyance for over four years now, with no signs of a satisfactory conclusion. But business, trade, investment analysts, and rating agencies are keeping their hopes pinned on GST.
The GST, designed to unify all indirect taxes to eradicate the scourge of cascading taxes at both the centre and states, has been through numerous iterations.
First, from a single GST it morphed into the dual central GST (CGST) to be levied by the centre, and the states levying a State GST (SGST). But because the states were not allowed tax services (an area reserved for the centre), the previous Congress-led government moved the 115th Amendment (GST) Bill in Parliament in March 2011. Partisan politics and paranoia about the centre encroaching on state turf ensured that the Bill lapsed. The government had to revise the draft at least four times to accommodate concerns from different states, and even then it faced stiff opposition from Bharatiya Janata Party-ruled states like Gujarat and Madhya Pradesh. The states opposed GST because it erodes their autonomy and powers to tax.
The new government has promised to pilot the Bill once again during the 2014 Winter session of Parliament; the Bill has to be passed by a two-thirds majority in both the Houses and by legislatures in half of the 29 states, in order to become law.
Some states are still demanding that residual issues—such as keeping petroleum products out of the GST’s ambit and not subsuming entry tax into GST, among others—be first settled. Many states with a large manufacturing base, such as Gujarat, have also expressed reservations against the fundamentals of a destination-based tax like GST when the consumption will take place in states like Bihar or Uttar Pradesh.
Even if we leave out the sectarian resistance, the GST battle reveals how fiscal federalism is being re-cast and redeveloped by the constant give-and-take between the centre and states. Indian-style fiscal federalism is also at work: in the interplay between the desire to achieve economic efficiencies (by reforming outdated legislation) and maintaining the delicate power-sharing equilibrium between the centre and states, change usually takes a backseat. Any rebalancing of this relationship is not easy, because the roles have been finely delineated by the Constitution.
Ironically, it was state representatives in the Constituent Assembly Debates who granted the centre more powers, given the exigencies of the time, especially the need for a “unitary” force. As a consequence, the centre has powers to levy income tax (except agricultural income), corporation tax, excise duty, service tax, and customs duty.
The states were empowered to collect land revenue, excise on liquor, tax on agricultural income, estate duty, tax on sale or purchase of goods, tax on vehicles, tax on professions, luxuries and entertainment, and stamp duties. This configuration vests the centre with a disproportionate revenue-collecting power, but encumbers states with the responsibility of executing development projects far in excess of their revenue-generating capabilities.
Indeed, India’s asymmetric federal architecture makes fiscal federalism indispensable. A vertical imbalance has been created by uneven powers of taxation between the centre and states. A horizontal imbalance is reflected in the varying standards of development among states, with some generating more revenue due to historical advantages or greater natural resource endowments.
In addition, some states are more autonomous than others. Jammu and Kashmir, for example, is governed by special provisions under its Instrument of Accession. Similarly, Article 371 of the Constitution grants different states exclusive rights, depending on deals struck when statehood was granted; for example, Article 371(D) protects the rights of local people in Andhra Pradesh to education and employment. And some states can send more representatives to the upper house than others: for instance, Uttar Pradesh has 31 seats in the Rajya Sabha while Maharashtra has only 19.
Given the unequal division of powers to collect revenue, the centre is mandated to share a part of its revenue with states. The formula for dividing revenues—or fiscal federalism—is the responsibility of the Finance Commission, a Constitution-mandated body that the president must set up every five years. The changing cast of characters with each successive commission has invested Indian fiscal federalism with immense flexibility. The Fourteenth Finance Commission is expected to submit its report by October this year.
Meanwhile, India’s fiscal federalism continues to suffer from many other inequities and gaps:
First, the unresolved issue of distributing revenues from the sale of “national commons.” The centre has exclusive rights to grant telecom licences, for instance, which necessitate the sale of spectrum or airwaves. These are national resources and, as such, belong to the country. Yet, their sale proceeds are never shared with the states.
The same applies to central licensing for the exploration of hydrocarbons. Take the example of mineral extraction: while the Constitution recognises the rights of states to regulate mines and mineral development, this acknowledgment is not unconditional. In fact, states must get the centre’s specific go-ahead for the extraction of major minerals, even though they may have the right to allow this exploitation. This exemplifies resource federalism gone awry. 1
Another example: under the central policy for hydropower projects, home states get only 12% free power from a project 2. This is not mandated by the Constitution. How was the 12% threshold calculated—why not or any other number?
The Thirteenth Finance Commission has already flagged the issue and, hopefully, the Fourteenth Finance Commission’s report, as well the political system, will take due note of this fact.
Two, the Thirteenth Finance Commission has highlighted the need for “environmental federalism” 3 whereby states with a large forest cover need to be compensated for not only providing a “public good” to the rest of the country but also for not being able to use land for other “productive” uses. The Thirteenth Finance Commission’s formula for providing grants to such states is an ad hoc measure that must be legislated into law.
Finally, the debate on fiscal federalism suffers from legacy compulsions. The 73rd and 74th constitutional amendments introduced a third layer to the government structure: panchayats and local bodies. While this layer is equally responsible for delivering governance and development, the debate over fiscal federalism seems to disregard its resource and revenue needs. The entire discourse on GST excludes the third tier.
It is evident that India needs some institution—like the Finance Commission—to keep vigil over the health of fiscal federalism and play the role of a fiscal watchdog. For example, the centre levies surcharges and cesses on all direct and indirect taxes, ostensibly to meet social expenditures; however, it is also true that revenues collected from this source are excluded from the centre’s divisible pool of revenue.
How does this fit with the centre’s powers to tax and the spirit of fiscal federalism? Only an enlightened fiscal federalism, which takes into account the interests and development of everyone in society, will help keep this republic together.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House. He has been a senior business journalist, and Executive Editor, The Economic Times, and served as Head, Policy and Research, at a private sector bank, before shifting to consultancy and policy analysis.
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References
1. Noronha, Ligia, N Srivastava, D Datt and P.V. Sridharan, ‘Resource Federalism in India: The Case of Minerals’, Economic & Political Weekly, 21 February 2009, Vol XLIV, No 8.
2. Ministry of Power, Government of India, Policy on Hydro Power Development, <http://www.indianelectricity.com/pdf/iepolicy/hydro/Document/hydro_power_policy_developmemt.pdf>
3. Thirteenth Finance Commission, Report, Chapter XIII, Looking Ahead: Towards A New Architecture for Federal Finance, <http://fincomindia.nic.in/writereaddata/html_en_files/oldcommission_html/fincom13/tfc/Chapter13.pdf>