Now that the GST compensation (GSTC) has come to an end (on June 30, 2022), expect capital expenditure to take a big hit as most states face revenue shocks. With GSTC and a 14% annual increase in it, states have continued to keep their capital expenditure above 3% of the GDP but that will change from FY23 unless the Centre reverses its decision on GSTC or finds new ways to compensate states for their shortfall in state GST (SGST).
Budget documents and the RBI report on state finances show states have spent an annual average of 3.1% of the GDP on capital expenditure, as against the Centre's 1.8% of the GDP, during FY12-FY22. Any tax shock will then adversely impact their ability to push capex.
The recent changes in GST rates, which the GST Council approved on June 29 – tax on hitherto exempted items and hike in rates for a large number of mass consumption items – is expected to raise about ₹15,000 crore, according to Revenue Secretary Tarun Bajaj. This is pittance, just 2.2% of the total GST collection of ₹6.75 lakh crore in FY22(RE), and will not fill the gap created by the discontinuation of the GST compensation.
The extent of the shortfall in SGST due to the discontinuation of GSTC is known accurately for FY21 and FY22 since the Centre borrowed ₹1.1 lakh crore in FY21 and ₹1.59 lakh crore, respectively, to compensate states. The 15th Finance Commission's estimation had shown the total shortfall in SGST to be ₹7.1 lakh crore during July 2017 to June 2022. The compensation may have ceased now but the shortfall in SGST will continue. But, by how much, is not known!
Here is an indication.
SGST shortfall for states
Finance Ministry think tank, National Institute of Public Finance and Policy (NIPFP), released its working paper 'Revenue Assessment of Goods and Services Tax (GST) in India' on July 6, 2022. It gives a fair idea.
It shows, the average annual share of compensation in SGST was 34% for 18 states during FY18-FY21. This means, discontinuation of the compensation will hit 34% of the SGST collections. In comparison, the recent hikes in GST rates will raise the GST revenue by a mere 2.2% – grossly insufficient.
Examination of individual states presents a depressing scenario. For Punjab, the GST compensation constituted 92.83% of its SGST during FY18-FY21, followed by Goa with 59.8%, Chhattisgarh with 48.3%, Karnataka with 43%, Odisha with 39.8% and Gujarat with 39.5%. These states will face higher tax revenue shocks compared to Telangana (11.4%) and Andhra Pradesh (13.4%), which are at the bottom. Even for Telangana and Andhra Pradesh, a 2.2% increase due to higher GST rates will not help much.
The study compared the revenue generated from the subsumed indirect taxes in the GST during 2015-2017 and compared it with that of SGST, including the compensation, during 2019-21 to find whether the GST had benefitted states.
Its finding says "majority of states could sustain the share of SGST in GSDP with GST compensation". As for improvement in tax post-GST, it says: "Our analysis shows that for majority of states the share of SGST collection (with GST compensation receipts) in GSDP do not show much increase during 2017-21 as compared to the share of revenue that is subsumed into GST in GSDP during 2015-17."
States are now doubly burdened because their "own tax revenue" or OTR has been stagnant for years. According to the RBI report, "State Finances: A Study of Budgets", the OTR has remained around 6% of the GDP in the past decade of FY13 to FY22 – varying between 6% FY16 and FY20 to 7.2% in FY22(BE).
GST hasn't improved Centre's tax revenue
The Centre's own tax collection hasn't improved either.
The NIPFP study shows the Centre's net tax revenue has been progressively falling from 8% of the GDP during FY06-FY10 to 7% during FY20-FY21. As per the 2022 budget, the Centre's gross tax receipt has fallen from a high of 11.2% of the GDP in FY17 and FY18 to 10.8% in FY22 and is estimated to fall to 10.7% in FY23(BE) – notwithstanding 11.1% "nominal" growth in the GDP.
One reason for the overall shortfall in tax is also because of the corporate tax cut of ₹1.45 lakh crore announced in September 2019. The NIPFP explains that the Centre has manged "to mitigate the revenue shortfall in GST" (notwithstanding robust growth in GST collections) by raising "non-shareable taxes" and "Cesses on commodities" on excisable goods under the Union Excise Duty (UED) – that is, raising taxes on three petroleum products (petrol/ gasoline, diesel, aviation turbine fuel), natural gas, crude petroleum and tobacco – which are not shared with states.
But states can't raise tax revenue because of its curtailed indirect tax rights – subsumed in GST, except for petroleum product, electricity and alcohol – and they don't have the same taxing rights as the Centre when it comes to direct taxes.
True, the Centre can raise more resources through disinvestment and privatisation and meet its own shortfall in revenue but the proceeds are not shared with state governments and hence, wouldn't do much for the capex push of states – which is, as pointed out earlier, is much higher than that of the Centre.
Budget documents show the Centre has also been consistently short-changing states in devolution of taxes by honouring the 14th and 15th Finance Commission awards. During the 14th Finance Commission period (2015-20) the annual average tax devolution was 34.9% when the award was 42% and came down to 29.5% during FY21 and FY22 when the 15th FC award was 41%.
GST mess endures
This brings to the fact that GST continues to be a work-in-progress after five years.
Petrol and petroleum products and electricity are two key items which remain out of its purview, along with alcohol for human consumption. Petroleum products and electricity are raw materials for production of goods and services. By keeping these out, the cascading effect of multiple indirect taxes that the GST tried to eliminate has been defeated.
The same goes for GST rates. Even after periodic changes in rates in the past five years, the multiplicity of tax slabs is mind boggling. These six slabs are: 0%, 1.5%, 5%, 12%, 18%, 28% plus Cess (including 'sin' tax) and "composition levy" of 1%, 2% and 5% for manufacturers, traders and suppliers up to annual turnover of ₹75 lakh – nine different tax slabs in all. When launched, the GST was supposed to herald "one nation, one tax, one market".
There is no reason why there can't be two or three slabs instead as the previous government intended to and former chief economic advisor Arvind Subramanian had proposed in his December 2015 document, "Report on the Revenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST)". Simplicity in tax structures help both in compliance and administration.
Besides, raising GST collection is both bad taxation and economics.
India's tax structure remains regressive with a higher burden of indirect tax – which hurts the poor more than the rich and violates the ability-to-pay taxation principle – rather than direct tax in the total tax collection. Burdening poor with more indirect tax – as the June 29 upward revision of GST taxes brought – when inflation is near 7% and is expected to remain over 6% for the entire fiscal is a bad idea. It would end up depressing consumption demand and drag down growth.
With the fear of recession looming large over the US – the old saying of "when the US sneezes the world catches a cold" is very much valid given its economic predominance – and global growth predicted to go down due to the Russia-Ukraine war induced supply disruption raising global inflation, India not only doesn't need any more hikes in GST, as was decided in the June 29 meeting of the GST Council, it needs to find new ways to boost capital expenditure for growth without hurting consumption demand. And as states spend 63.3% of the total on capex, they need more support from the Centre, rather than less.
One good way is to raise direct tax: by reinstating wealth tax and withdrawing corporate tax cut, if not raising it to match with the soaring corporate profits in FY21 and FY22. But that possibility is remote. The other is to devolve more tax revenue to states by honouring the Finance Commission reports and sharing the proceeds of disinvestment and privatization. That possibility too seems bleak.
It is a classic catch-22 situation which may eventually end up hurting India's growth in FY23 and going forward.