GST – Grand Bargain 2.0

Source– The Hindu

Context– A Grand Bargain 2.0 between the center and the states is needed in longer run to tackle the issues related to GST compensation to the States.

Value added tax [VAT] – An indirect value added tax which was introduced into Indian taxation system on April 1, 2005. VAT was introduced to make India a single integrated market. On June 2, 2014, VAT was implemented in all states and union territories of India, except Andaman and Nicobar Islands and Lakshadweep Islands.

Disadvantages of VAT

  1. Cascading effect of taxes – Cascading effect is when there is tax on tax levied on a product at every step of the sale. The tax is levied on a value which includes tax paid by the previous buyer, thus, making the end consumer pay “tax on already paid tax.”
  2. It was not possible to claim Input Tax Credit (ITC) on service under VAT.
  3. Different VAT rates and laws in different states.

The need for one country one tax was envisaged by GST which is a single comprehensive destination-based tax.

GST [Compensation to States] Act, 2017

  • States are guaranteed the compensation for loss of revenue on account of implementation of GST for a transition period of five years (2017-22).
  • The compensation is calculated based on the difference between the states’ current GST revenue and the protected revenue after estimating an annualized 14% growth rate from the base year of 2015-16.

Issues raised by States in current GST model

  1. Limited option for States to raise money -States does not have recourse to multiple options that the Centre has, such as issue of a sovereign bond in dollars or rupees.
  2. Rate of market borrowing -Centre can anyway command much lower rates of borrowing from the markets as compared to the States.
  3. Rate of public sector borrowing-In terms of aggregate public sector borrowing, it does not matter for the debt markets, or the rating agencies, whether it is the States or the Centre that is increasing their indebtedness.
  4. Fiscal Stimulus– Fighting this recession through increased fiscal stimulus is basically the job of macroeconomic stabilization, which is the Centre’s domain thus states can’t overcome the impact of fall in revenue which is more or less lockdown induced.
  5. Trust issue -Breaking this important promise, using the alibi of the COVID-19 pandemic causes a serious dent in the trust built up between the Centre and States.

Possible solutions

  1. Low GST rate -A low moderate single rate of 12% encourages better compliance, reduces the need to do arbitrary classification and discretion, reduces litigation and will lead to buoyancy in collection.

Example- Australia, for the past two decades their GST rate has been constant at 10%.

  1. Importance of 3rd tier government -Of the 12% GST, 2% must be earmarked exclusively for the urban and rural local bodies, which ensures some basic revenue autonomy to them. The actual distribution across panchayats, districts and cities would be given by respective State Finance Commissions.
  2. Low transaction cost – The current system is too complex and burdensome. An overhaul of the interstate GST and the administration of the e-way bill to reduce the transection cost and also need to zero rate exports.

Way forward

GST is a crucial and long-term structural reform which can address the fiscal needs of the future, strike the right and desired balance to achieve co-operative federalism and also lead to enhanced economic growth. The current design and implementation has failed to deliver on that promise. A new grand bargain is needed.

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