Context: The “one state one vote” structure under GST Council is a flawed one. It needs to be replaced with a proportional representation of voting in the GST Council. This system should be based on the size of states or their revenue contribution to the GST pool.

• The article highlights the issues with the one state one vote system adopted in the GST Council decision making.

Background

• In the recent GST Council meeting, there is a debate going on, whether to tax or not to tax on products essential to fighting Covid-19.
• 12 states, representing nearly 70% of India’s population, agree to make such products tax-free.
• But,19 states, representing the remaining 30% of the population, want to continue to levy GST on these products.
• The lack of consensus can largely be explained by the distorted design and incentive structure of the GST itself.

Distribution methodology for taxes collected under GST

• The GST Council has representatives from all states. According to “one state one vote” all the representative have equal voting rights in GST Council.
• The taxes collected under GST (from states) are accumulated by the Union government and a portion is transferred back to each state under a formula.

States contribute maximum to the GST pool

• Four states: Maharashtra, Tamil Nadu, Karnataka, and Gujarat contribute nearly as much (~45%) of the total GST pool

Source of revenue for the states in India
Every state in India has two major components of revenues. These are,

• State’s own revenues
• Transfers from the Union government, consisting of both share of taxes collected by the Union and grants.
• How the source of revenue differs for bigger and smaller states?
• Only about 30% of the overall revenue of the 4 big states, namely, Maharashtra, Tamil Nadu, Gujarat, and Karnataka, comes from the Union government.
• But for the remaining 27 states, roughly 60% of their revenues are obtained through transfers from the Union government.
• For the smaller Northeastern states, these transfers from the Union government constitute 80-90% of their total revenues

Negative trends in the revenue collection & distribution in India

• Imbalance in collection & distribution of taxes between states: As mentioned above,
• While four big states contribute around 45% to the GST pool, they are the least dependent on the Union government for their revenue needs.
• Whereas smaller states which contribute less to the GST pool are more dependent on the Centre’s transfers for their revenues.

So,

• States that are more dependent on transfers from the Union want to maximize GST collections. This is why they are in support of taxation on Covid-related products.
• Whereas bigger states that are less dependent can afford to be more sensitive to citizens’ concerns and are against taxing Covid related products.

With time, net transfers from center should decrease as states come at par in development relative to each other. But in India over the past few years, these net transfers have increased.

• States are getting a lower share of revenues: States’ revenue has declined owing to unfair taxation practices by the Center. For instance,
• Increase in cesses: The Union has shifted a large proportion of taxation (roughly 18% of its overall revenues) into cesses. This remains outside the GST pool and hence do not have to be shared with the states
• So, the GST model based on “one state one vote” causes grave injustice to the developed states.

Road Ahead

• A system of proportional representation, instead of one state one vote model, would not have resulted in this lack of consensus. A proportional representation of voting in the GST Council either as a proportion of the size of a state or by its contribution to the GST revenue pool is the ideal way forward.