Context: Fifteenth Finance Commission (FFC) chairman N.K. Singh sought a leverage with the Goods and Services Tax (GST) Council, arguing that tax rate cuts and grant of exemptions decided solely by the council affects the FFC’s goal of optimizing revenue targets of the Centre and states.

What is the issue?

• Given the poor GST collection trend so far many states have urged the Finance Commission to extend the period for GST compensation beyond the initial five years. 
• The 15th Finance Commission suggested that annual growth rate of 14% for compensation is too high and should be lowered for the remaining compensation period. States are not in favour of this.

Finance Commissions’ problems:

• Finance commissions look at projections of revenue and spending, but GST rates, exemptions, changes and implementation are the domain of the GST Council. 
  • This leads to unsettled questions on the ways to monitor, scrutinize and optimize revenue outcomes.
• Demand from states for extending the GST compensation given to them for revenue shortfall beyond the currently agreed 2022 will also have a bearing on the formula the FFC is set to recommend on how the Centre should share its tax revenue with states.
  • The FFC’s formula for revenue sharing is effective for five years from April 2020.  An extension of GST compensation to states beyond 2022 will impact the last three years of the period, for which FFC’s recommendations will apply, that is between FY23 and FY26.
• The difference between the estimate and actual revenue collection of the centre will be a compelling factor for the incumbent 15th Finance Commission.
• FFC’s suggestions for revenue sharing could be more tight-fisted than states expect, which could trigger more friction between the Union and state governments.

States’ problem:

• The 14th Finance Commission recommended “increasing the share of tax devolution to states to  42 percent of the divisible pool.
• Applying the 14th Finance Commission’s formula of 42 percent devolution, the centre’s current rate reduction implies a shortfall of Rs 60,900 crore for the states.

Centre’s problems:

• The Union government is facing the challenge of finding the money for higher welfare spending on schemes such as farmers’ income support, as well as the burden of compensating states, when its own revenue growth is sluggish.
• India’s GDP growth rate slipped to a six-year low of 5% in the first quarter of the ongoing fiscal year.

Concerns:

• Continuous fall in GST collection: The gross GST collection in August 2019 grew 4.51 per cent year-on-year to Rs 98,202 crore but continued to remain below Rs 1 lakh crore mark reflecting the economic slowdown realities on the ground. The GDP growth in the April-June quarter slowed to a six-year low of 5 per cent. 
• The cumbersomeness of compliance of GST: The GST registration processes are still relatively cumbersome, making compliance both expensive and time-consuming. In addition, the return filing procedures are tedious. 
  • Taxpayers have found it difficult to claim input credits, the basic foundation on which the tax rests.
• States’ fiscal autonomy circumscribed by GST: Indirect taxes were completely under the control of each state, GST rates are now decided by the GST Council. Now states have limited flexibility in making decisions regarding tax rates on goods and services. Therefore, higher reliance on GST receipts for revenue reduces states’ autonomy.
• Fake and under-invoicing - Officials estimate that evasion through fake and under-invoicing could be pegged at anywhere between one per cent and five per cent of collection.
• The failure to reach a consensus on rationalisation of rates - States’ refusal for inclusion of items such as petroleum products and electricity in the GST’s ambit.
• The delay in refunds: The delays often force traders to resort to human interfaces, a practice that is a slippery slope towards bribery.
• No clear defining of the role of the Niti Aayog, which as of now does not have any powers to take financial decisions.
• Conflict between the original Seventh Schedule and the use of Article 282 to initiate a large number of Centrally Sponsored Schemes: There are 211 CSSs on which the government spends over Rs 3.32 lakh annually. Article 282 comes under the category of something called the miscellaneous provisions. It was to be used under exceptional circumstances. But exception became the rule and Centrally Sponsored Schemes proliferated under Article 282.
• Prioritizing "political expediencies" over "constitutional misgivings" has ensured that the states haven't complained against such "transgressions".
• Off-budget borrowings by both the Centre and the states to side-step financial reporting requirements.
• Tax buoyancy: While the direct tax buoyancy seemed to be doing well, it was the indirect tax buoyancy that worries. Higher tax rates do not automatically imply high tax collections or tax-buoyancy. 

Way forward

• Simplifying GST
  • Improve the quality of GST compliance, fixation of rate structure, reducing the cumbersome compliance procedures, minimise the cost of compliance to improve collection.
  • The concept of input tax credit also needs to be better explained, and its rules clarified, even standardized at some point.

• The symmetry in the working of the GST Council and the Finance Commission for better ways to monitor, scrutinize and optimize revenue outcomes.
• Rationalization of centrally-sponsored schemes to reduce the burden on central government.
• Restructuring GST Council: It needs restructuring in terms of what is good, not only in terms of the negotiating strengths of one state versus the other, but also in the realm of fiscal federalism.
  • Need to rethink the fiscal partnerships to catapult growth, and not look at it merely as a way to garner more revenue from a particular state.
• Fresh look at Schedule 7 of the Constitution that assigns lawmaking powers on various subjects to Central and state governments.

The purpose of the Inter-State Council is to bring about greater coherence not necessarily for conflict resolution but for a greater congruence and coordination between the centre and States. There should be a mechanism by which GST Council and Finance Commission can coordinate.