The Goods and Services Tax (GST), introduced in July 2017, was a landmark reform in India’s indirect tax system. It replaced multiple State-level taxes with a unified State GST (SGST) and aimed to simplify tax structures and boost revenue. This reform had implications for States’ fiscal health and autonomy. The following sections break down the key aspects of GST’s impact on States.
GST Implementation and Structure
GST subsumed taxes like value added tax, sales tax, luxury taxes, and entry tax into SGST for intra-State transactions. For inter-State sales and imports, Integrated GST (IGST) is collected by the Centre and then shared with destination States after input tax adjustments. This destination-based tax system was designed to eliminate cascading taxes and streamline revenue collection.
Compensation Mechanism for States
To address States’ revenue concerns, especially manufacturing States fearing losses, the Centre guaranteed a 14 per cent annual growth in GST revenue for five years from a 2015-16 baseline. This compensation was funded by a cess on luxury and demerit goods. It aimed to protect States from initial revenue shortfalls and ensure fiscal stability.
Revenue Growth Trends and Challenges
Before GST, most States’ subsumed taxes grew below 14 per cent annually. Post-GST, some States achieved or exceeded this benchmark, but many faced fluctuations due to rate cuts and economic disruptions like the Covid-19 pandemic. Between 2017 and 2022, actual GST revenues in major States fell short of projections, necessitating compensation and loans from the Centre.
State-wise Revenue Outcomes
Four States—Gujarat, Kerala, Punjab, and Tamil Nadu—received compensation exceeding their projected revenue. Others like Haryana, Madhya Pradesh, Odisha, West Bengal, and Andhra Pradesh faced shortfalls. Variations arose partly because compensation was based on preliminary GST collection estimates, which were subject to revision.
Post-Compensation Revenue Scenario
After the compensation period ended in 2022, most States showed GST revenue growth exceeding 14 per cent, except Himachal Pradesh and Kerala. However, actual collections remained below the 2015-16 based projections. When measured against pre-GST growth rates, actual GST revenue gains were positive for most States, especially Maharashtra, Gujarat, Uttar Pradesh, and Tamil Nadu.
Impact on Fiscal Federalism and Tax Autonomy
GST empowered States to tax services and harmonised indirect taxation, reducing fiscal disparities. Industrial States disproved fears of revenue loss. Despite initial challenges, GST helped stabilise State revenues, especially during the pandemic. The compensation mechanism played a critical role in maintaining fiscal balance.
Future Prospects and Reforms
The Group of Ministers recently recommended simplifying GST rates from four slabs to two — 5 per cent and 18 per cent. This change aims to ease compliance and reduce the need for compensation. The continuation of the compensation cess beyond 2025 remains undecided. Its future will influence the tax-to-GDP ratio and States’ fiscal health.
Questions for UPSC:
- Discuss the impact of the Goods and Services Tax on fiscal federalism in India with examples of State revenue changes post-GST implementation.
- Critically examine the role of compensation mechanisms in maintaining fiscal stability among Indian States during economic disruptions like the Covid-19 pandemic.
- Explain the challenges and benefits of implementing a destination-based tax system in a federal structure like India’s.
- With suitable examples, discuss the implications of tax rate rationalisation on revenue collection and economic growth in India.
