India’s GST – Challenges in Cooperative Federalism

India’s Goods and Services Tax (GST), launched eight years ago, was hailed as a landmark in cooperative federalism. It required the Centre and states to pool tax sovereignty and jointly manage indirect taxes through the GST Council. This was meant to create a unified market and deepen fiscal cooperation. However, recent developments reveal persistent challenges in this grand bargain. The Centre’s dominance and states’ fiscal anxieties have led to a fragile and often contested federal relationship.

Background of the GST Grand Bargain

The GST was designed as a cooperative federal framework. The Centre agreed to share tax powers, while states surrendered some fiscal autonomy. The GST Council, comprising representatives from both, was established for collective decision-making. This was unlike earlier federal institutions, as it emerged from states’ initiative, not Centre’s imposition. The goal was to harmonise indirect taxes and create a seamless national market.

Fiscal Federalism and Power Imbalance

India’s fiscal federalism is marked by a two-third, one-third divide. The Centre controls most revenue sources but states bear the majority of expenditure responsibilities. The Finance Commission transfers funds to states, but delays and cess impositions have strained relations. This imbalance creates a moral hazard where states rely heavily on Centre’s transfers instead of enhancing their own tax efforts. The Centre often uses its revenue powers to centralise control, undermining the federal spirit.

Political Culture and Zero-Sum Bargaining

The GST negotiations exposed a political culture focused on revenue extraction rather than cooperation. Producer states feared revenue loss and insisted on compensation, while consumer states viewed GST as a revenue gain. This led to compensation becoming the main bargaining tool. States often approached GST as a zero-sum game, seeking immediate fiscal benefits rather than long-term tax harmonisation. The Centre’s assertive moves further fuelled mistrust.

GST Council’s Role and Recent Developments

The GST Council was intended as a platform for consensus. However, recent rate rationalisation was announced by the Prime Minister directly, bypassing collective decision-making. This move brought into light the Centre’s dominance and the Council’s weakened role. While the Council debated reforms, the final decisions appeared centrally driven. States’ concerns, especially on compensation, were sidelined, reflecting a decline in cooperative federalism.

Implications for India’s Fiscal Federalism

The GST experience shows the limits of India’s fiscal federal design and political culture. States have not fully utilised their tax powers due to political costs. The Centre’s control over revenues and delays in transfers discourage genuine cooperation. The GST Council, meant to be a federal forum, struggles with trust deficits and power imbalances. This situation hampers the vision of a unified market and effective cooperative federalism.

Future Prospects and Challenges

For India to realise the full potential of GST, a renewed commitment to federal principles is essential. Both Centre and states must move beyond short-term fiscal gains. Strengthening the GST Council’s autonomy and enhancing states’ fiscal capacities are key steps. Without addressing these structural and political issues, GST risks remaining an imperfect compromise rather than a model of cooperative federalism.

Questions for UPSC:

1. Point out the challenges faced by cooperative federalism in India’s fiscal structure and suggest reforms to strengthen it.
2. Critically analyse the role of the GST Council in India’s tax federalism and its impact on Centre-state relations.
3. With suitable examples, estimate how political culture influences fiscal federalism in India and its implications for governance.
4. Underline the significance of the Finance Commission in India’s fiscal federalism and how it affects state finances and autonomy.

Answer Hints:

1. Point out the challenges faced by cooperative federalism in India’s fiscal structure and suggest reforms to strengthen it.

1. Centre controls majority of revenue sources; states bear most expenditure responsibilities (two-third, one-third problem).
2. States depend heavily on Centre’s transfers; delays and cess impositions strain relations and trust.
3. States avoid raising own taxes due to political costs, relying on Centre’s fiscal space.
4. Political culture promotes zero-sum bargaining over cooperation, focusing on short-term gains.
5. GST Council’s weakened autonomy limits genuine federal negotiations.
6. Reforms – Enhance states’ tax powers (e.g., property/agriculture taxes), timely revenue transfers, strengthen GST Council’s decision-making independence, promote long-term cooperative fiscal policies.

2. Critically analyse the role of the GST Council in India’s tax federalism and its impact on Centre-state relations.

1. GST Council designed as a cooperative federal forum with Centre and states sharing tax powers.
2. Initially a novel institution emerging from states’ initiative, not Centre’s imposition.
3. Recent decisions (e.g., GST rate cuts) announced by Centre bypassing Council consensus, undermining its role.
4. Council’s consensus often stage-managed; states’ concerns, especially compensation, sidelined.
5. Centre’s dominance and delayed transfers erode trust, pushing states towards zero-sum bargaining.
6. Overall, GST Council’s limited autonomy weakens cooperative federalism and strains Centre-state fiscal relations.

3. With suitable examples, estimate how political culture influences fiscal federalism in India and its implications for governance.

1. Political culture prioritizes immediate revenue extraction over long-term cooperation (zero-sum mindset).
2. Producer states focus on compensation to avoid revenue losses; consumer states view GST as revenue gain.
3. Example – States bargaining for compensation rather than tax harmonisation in GST negotiations.
4. Partisan politics affect consensus-building; BJP-ruled states align with Centre, limiting opposition voices.
5. This culture discourages states from using own tax powers due to political costs.
6. Implications – Weakens federal trust, encourages fiscal centralisation, hampers unified market and governance reforms.

4. Underline the significance of the Finance Commission in India’s fiscal federalism and how it affects state finances and autonomy.

1. Finance Commission recommends tax devolution and grants from Centre to states, crucial for state finances.
2. Acts as a constitutional mechanism to balance Centre-state fiscal relations.
3. Delays or inadequacies in transfers create fiscal stress and mistrust among states.
4. Formula-based devolution can’t fully address states’ diverse needs or incentivize tax effort.
5. Excessive dependence on Finance Commission transfers reduces states’ fiscal autonomy and tax innovation.
6. Strengthening timely, needs-based transfers and incentivising states’ own revenue efforts can improve autonomy and cooperative federalism.