GST reform: Opposition-ruled states demand compensation for revenue loss

In the run-up to the Goods and Services Tax (GST) Council meeting on September 3 and 4, a group of eight non-BJP ruled States have proposed a cess to be levied on sin and luxury goods over and above the proposed 40% GST rate, in a bid to protect the States’ revenues. 

Without such a cess, the revenue losses from the Centre’s proposed rate rationalisation, which they estimated as at least 15%, would “drastically” hamper their expenditure on development, they warned. 

The Centre has proposed removing the 12% and 28% tax slabs and moving the vast majority of items in these slabs to 5% and 18%, respectively. It has also proposed a 40% rate for a few sin and luxury items.

‘Serious concerns’

The Finance Ministers of Himachal Pradesh, Jharkhand, Karnataka, Kerala, Punjab, Tamil Nadu, Telangana, and West Bengal met in New Delhi on Friday and drafted a note, accessed by The Hindu, in which they laid out their concerns and proposals. The note will be submitted to the GST Council when it meets.

“The revenue implications on States due to the GST rate rationalisation proposals made by the Center have been discussed in the meeting,” Telangana Deputy Chief Minister and Finance Minister Bhatti Vikramarka Mallu said, following the meeting. “A consensus has been reached by these States to extend their in-principle support to the proposal of GST rate rationalisation.” However, he added that “serious concerns” were expressed in the meeting about the losses that States may incur, which would adversely impact their welfare schemes.

Revenue shock

“The first and foremost concern is the severe impact on State revenues,” the note said. “States depend heavily on GST as their principal source of revenue whereas the Centre has a far broader revenue base with substantial inflows from direct taxes, large dividends from public institutions, custom & excise duties, cesses and surcharges.” 

The note explained that the Centre also has a larger capacity to raise borrowings which can act as an effective counter-cyclical measure in times of revenue uncertainty. It added that GST revenue makes up only 28% of the Centre’s tax revenue, but half of the States’ own tax revenues, underscoring their dependence on this revenue stream.

The eight States which drafted the note said they anticipate a revenue reduction of between 15% and 20% if the rationalisation of rates is carried out.

“Such a revenue shock cannot be absorbed by the States without drastically reducing developmental expenditure,” the note said. “Therefore, any rate rationalisation will have to be accompanied with adequate safeguards to protect the fiscal stability of the States.”

Extra tax on sin, luxury goods

The States argued for an “additional levy” that could be imposed on sin and luxury goods, over and above the 40% rate proposed by the Centre. 

“The proceeds of this levy should be fully distributed among the States as a necessary measure to safeguard States’ revenues, discourage the use of sin goods, and promote public health,” they said.

Sin goods include items like tobacco, cigarettes, and ghutka, while luxury items are typically high-value cars and other high-end services such as business class and first class flight tickets.

Five year revenue protection

The note added that the States should be compensated on the assumption of a 14% annual growth in their GST revenues. If the additional levy fails to ensure this growth, then the Centre should “raise loans secured against the future receipts of the additional levy” to compensate the States, they said.

This was the procedure followed in the aftermath of the COVID-19 pandemic when the GST compensation cess collections fell short of the States’ compensation needs.

“Revenue protection must be guaranteed for a minimum of five years,” the note said. “This duration is necessary to provide States with the stability required for medium-term fiscal planning. Beyond this period, the arrangement may be reviewed periodically in line with GST growth and buoyancy.”

Such a mechanism would be similar to the GST compensation cess mechanism implemented at the start of the GST regime in 2017, which guaranteed the States compensation for any revenue loss that arose from the implementation of GST, for a period of five years.