August 31, 2020
The union government and states are squabbling over the Goods & Services Tax (GST). Along the lines of the 1977 classic song by Billy Joel – “They started to fight when the money got tight and they just didn’t count the tears.”
GST was launched with characteristic bombast in a midnight ceremony on July 1, 2017 in the Central Hall of parliament, intended to evoke a parallel with the historic “Freedom of Midnight” event at the same venue on August 15, 1947.
The promises of GST were lofty: a new era of cooperative federalism that would usher in a ‘One Nation, One Tax, One Market’ regime and boost economic growth.
In ten quarters since that midnight launch, economic growth has declined consecutively for the last eight quarters. This was before Covid-19. GST may not have caused the economic slowdown but there was no evidence of the promised fillip to economic growth either. Further, the GST regime slapped businesses with tremendous bureaucratic complexity and hurt small businesses enormously. GST was stuttering even before Covid-19 hit the world.
The Covid-19 lockdown has brought India’s economy to a grinding halt and depleted government coffers. As per the original agreement with the union government, the states are entitled to a minimum guaranteed amount of GST revenues every year until 2022, after which they will share the economic risks jointly.
The union government has now thrown its hands up in the air claiming that Covid-19 is an “Act of God” and it is therefore unable to pay the states its obligated share of GST revenues. In return, the states claim that they have been dealt a double whammy – denied their legitimate share of funds while also having to incur additional expenditure to fight the epidemic. This has led to a bitter standoff. The states are asking the centre to fulfil its commitment; the centre has thrown rule books, legal opinions and the nationalism card at the states.
The union government in its August 29 communique to the states attempted to take the moral high ground by claiming that ideally, the centre and states should be sharing the losses arising from this unforeseen ‘Act of God’ predicament but nevertheless, it will be magnanimous and still try to fulfil its financial obligations.
But available financial resources are insufficient to fulfil these obligations and money needs to be borrowed. Who should borrow is the bone of contention. The union government argues that states should borrow money on their own and repay it through future GST cess collections. States argue that the union government is obligated to pay them and hence, it should be the one to borrow.
Here is where the union government throws the nationalism card at the states. It argues that if the centre were to borrow, it would pose macroeconomic risks such as increased interest rates for all borrowers, including corporates, which would be detrimental to the larger economy. So, in the larger interest of the nation, the states should shoulder this burden, since borrowing by states does not pose similar macroeconomic risk, it argues.
This is a flawed economic argument. The union government is right to worry about the ramifications of excessive borrowing. The consequences could be a downgrade of India’s ratings to ‘junk’ by international sovereign ratings agencies, higher borrowing costs for all others in the economy and crowding out of the private sector with insufficient capital availability. But the union government is wrong in its argument that these risks will be diminished or vanish if they can just offload the burden of borrowing to the states and not carry it on their books.
Ratings agencies consider all combined government debt including that of states and the centre for ratings purposes. They understand that even if state governments were to borrow, the debt is implicitly guaranteed by the union government and hence, the risks are the same.
Interest rates will rise for everyone in the economy regardless of whether it is the union government or the states who borrow. Ultimately, all money for borrowing comes from the domestic savings pool. When demand for borrowing goes up, interest rates will also rise. Increase in rates and crowding out of the private sector is not predicated on who the borrower is.
The economic rationale cited by the union government for absolving itself of the responsibility of borrowing and fulfilling its GST obligations to the states is shallow. But this GST issue is larger and goes beyond bureaucratic legalese or economics.
GST has been stitched together with a fabric of trust between the union and the states. The union government’s actions thus far to resolve this impasse run the risk of tearing this fabric of trust and destroying GST’s foundation.
To better comprehend the current imbroglio between the centre and states over GST, it is useful to imagine the counterfactual. If it were the year 2016 and ‘Covid-16′ had brought the nation’s economy to a halt, how would the situation have played out in the non-GST era? States’ finances would still have been in utter disarray. But they would have had their fiscal autonomy and powers. They would not have had to beg the centre and be at its mercy to access their own rightful share of revenues. They could have resorted to taxation policies specific to their state to raise more revenue. None of these are possible under a GST regime.
GST stripped elected state governments of all their fiscal powers and autonomy. An elected Chief Minister of a state in India today does not have any powers to raise meaningful tax revenues to govern her state. A democratically-elected government with no taxation powers is unheard of and unprecedented in any democracy anywhere in the world. Until now, the costs of GST in terms of loss of fiscal powers of the states far exceed any economic benefits. I warned precisely of this in an earlier article.
States agreed to sacrifice their fiscal powers for GST in ‘national interest’ on the foundation of trust and confidence in the union government. It is this harmonious spirit that the centre now needs to uphold and be large-hearted in borrowing and fulfilling its obligations to the states. Rules by bureaucrats, legalese by lawyers and analysis by economists are cold, futile methods to resolve this crisis when the need of the distressed hour is a warm, empathetic hand of the political leadership.
(Praveen Chakravarty is a political economist and a senior office bearer of the Congress party.)
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