Resource Sharing Between Union and State Governments: Goods and Services Tax (GST)

Introduction to Fiscal Federalism

In a federal system like India's, the Constitution divides powers and responsibilities between the Union (Central) government and the State governments. This division extends to the power of taxation. Fiscal federalism deals with how these different levels of government raise and spend money. The key to a well-functioning federal economy is an equitable and efficient system of resource sharing, ensuring that both the Union and the States have adequate financial resources to fulfill their respective constitutional duties and promote the welfare of citizens.

Historically, the division of taxing powers in India has been a source of contention. The Union government traditionally held more lucrative tax bases, leading to a situation where States were often dependent on the Centre for grants and financial assistance. This dependence could sometimes impact the fiscal autonomy and policy choices of the States. The design of resource sharing mechanisms, therefore, aims to balance the financial needs of both levels of government while promoting national economic integration and development.

Constitutional Provisions for Resource Sharing

The Indian Constitution, particularly Part XII, outlines the framework for financial relations between the Union and the States. Key articles include:

• Article 268: Taxes levied and collected by the Union but assigned to States.
• Article 269: Taxes levied and collected by the Union but assigned to States (e.g., taxes on sale/purchase of goods in the course of inter-state trade or commerce).
• Article 270: Taxes levied and distributed between the Union and States (e.g., income tax, excluding agricultural income tax).
• Article 275: Grants-in-aid to States from the Union.
• Article 280: Constitution of the Finance Commission, which recommends the distribution of net proceeds of taxes between the Union and States and the principles governing grants-in-aid.

The Finance Commission is a crucial constitutional body that plays a pivotal role in recommending the vertical and horizontal distribution of tax revenues. Vertical distribution refers to the division of tax proceeds between the Union and the States, while horizontal distribution deals with the share of each State within the total State pool.

Evolution of Indirect Taxation in India

Before the introduction of GST, India's indirect tax system was complex and fragmented. Several indirect taxes were levied by both the Union and the State governments, leading to issues such as:

• Cascading Effect: Taxes were levied on taxes, increasing the final cost of goods and services. For example, excise duty was levied by the Centre, and then Value Added Tax (VAT) was levied by the States on the price inclusive of excise duty.
• Multiple Taxation: Different taxes like Central Excise, Service Tax, State VAT, Central Sales Tax, Entry Tax, Luxury Tax, etc., were levied at various stages of production and distribution.
• Classification Disputes: Ambiguity in classifying goods and services led to disputes and litigation.
• Inland Tax Barriers: Taxes like Entry Tax and Octroi created barriers to the free movement of goods within the country, hindering the development of a unified national market.
• Complexity and Compliance Burden: The multiplicity of taxes and varying state-level rules made compliance difficult and costly for businesses.

These issues hampered economic growth, discouraged investment, and reduced the competitiveness of Indian goods and services in the global market. Recognizing these challenges, the need for a comprehensive reform in indirect taxation became evident.

The Goods and Services Tax (GST): A Paradigm Shift

The Goods and Services Tax (GST) was introduced in India on July 1, 2017, through the 101st Constitutional Amendment Act, 2016. It is a landmark indirect tax reform that subsumed a multitude of central and state indirect taxes into a single, unified tax. The primary objective of GST is to create a common national market for goods and services, thereby enhancing economic efficiency and promoting seamless movement of goods across the country.

GST is a destination-based consumption tax. This means that the tax is levied at the point of consumption of goods and services, rather than at the point of origin. This fundamental change addresses the issue of tax cascading and creates a level playing field for businesses across different states.

Structure of GST in India

India adopted a dual GST model, which means that both the Union and the State governments levy GST on intra-state transactions. The key components of this dual structure are:

• Central Goods and Services Tax (CGST): Levied by the Central government on intra-state supplies of goods and services. The revenue from CGST goes to the Central government.
• State Goods and Services Tax (SGST): Levied by the State governments on intra-state supplies of goods and services. The revenue from SGST goes to the respective State governments.
• Integrated Goods and Services Tax (IGST): Levied by the Central government on inter-state supplies of goods and services. IGST is the sum of CGST and SGST. The revenue collected from IGST is apportioned between the Centre and the destination State, ensuring that the tax revenue accrues to the state where the goods or services are consumed.
• Union Territory Goods and Services Tax (UTGST): Levied by the Union Territories on intra-state supplies of goods and services within their jurisdiction.

For imports into India, Integrated Goods and Services Tax (IGST) is levied, which is equivalent to CGST + SGST. This ensures that imported goods are taxed at par with domestically produced goods.

Taxes Subsumed by GST

GST replaced a wide array of indirect taxes. Understanding which taxes were subsumed is crucial for grasping the magnitude of the reform:

Central Taxes Subsumed:

• Central Excise Duty
• Additional Excise Duties
• Service Tax
• Excise Duty levied under the Medicinal and Toilet Preparation (Excise Duties) Act
• Additional Duties of Excise (Goods of Special Importance) Act
• Special Additional Duty of Customs (SAD)
• Cesses and Surcharges relating to supply of goods and services (e.g., Swachh Bharat Cess, Krishi Kalyan Cess)

State Taxes Subsumed:

• State Value Added Tax (VAT)
• Central Sales Tax (CST)
• Purchase Tax
• Entry Tax (all forms)
• Entertainment Tax (except those levied by local bodies)
• Luxury Tax
• Betting and Gambling Tax
• Cesses and Surcharges relating to supply of goods and services (e.g., State Education Cess)

It is important to note that certain taxes, like those levied and collected by local bodies (e.g., property tax, entertainment tax levied by municipalities), alcohol for human consumption, and petroleum products (though brought under GST Council's recommendation framework), were kept out of the GST ambit initially.

GST Council and Resource Sharing Mechanism

The GST Council is the apex decision-making body for GST in India. It is a constitutional body established under Article 279A of the Constitution. The Council comprises:

• The Union Finance Minister (Chairperson)
• The Union Minister of State for Revenue
• The Finance Ministers of all States and Union Territories with legislatures.

The GST Council plays a critical role in recommending:

• Taxes, cesses, and surcharges to be levied by the Union, States, and Union Territories.
• Goods and services that may be subjected to or exempted from GST.
• Model GST laws, principles of supply, situs of supply, classification of goods and services.
• The threshold limits of turnover for exemption from GST.
• The rates of GST (including floor rates with bands).
• Special provisions for certain States.
• The date on which GST shall be levied on petroleum crude, high-speed diesel, motor spirit (petrol), natural gas, and aviation turbine fuel.
• Issues relating to GST compensation to States.

The decisions in the GST Council are taken by a three-fourths majority of the votes cast, with the Centre having one-third of the total votes and the States having two-thirds of the total votes. This structure ensures that both the Centre and the States have a significant say in the formulation and implementation of GST policies.

GST and Inter-Governmental Fiscal Relations

GST has fundamentally altered the fiscal relationship between the Union and the States. The introduction of IGST for inter-state transactions and the mechanism for its settlement are key aspects of this new relationship.

• Destination Principle: The revenue from IGST on inter-state sales accrues to the destination state (the state where the goods or services are consumed). The Centre collects IGST and then transfers the appropriate share to the destination state. This ensures that states with higher consumption benefit from tax revenues, aligning tax collection with economic activity.
• Input Tax Credit (ITC): A crucial feature of GST is the seamless flow of Input Tax Credit (ITC). Businesses can claim credit for taxes paid on inputs (raw materials, services) used in the production or supply of goods and services. This ITC can be utilized to offset their output tax liability (CGST, SGST, or IGST). This mechanism ensures that tax is levied only on the value addition at each stage, eliminating the cascading effect.
• Compensation Mechanism: To ensure that States did not suffer revenue losses during the transition to GST, a Goods and Services Tax (Compensation to States) Act, 2017, was enacted. This Act provided for compensation to States for any revenue shortfall for a period of five years from the commencement of GST (July 1, 2017). The compensation was levied as a Cess on certain goods.

The implementation of GST has led to a more unified and transparent tax system. While challenges remain, it has significantly improved the ease of doing business and has the potential to boost economic growth by creating a more integrated national market. The GST Council's continuous efforts to streamline the system and address issues demonstrate a collaborative approach to fiscal federalism.

Impact on Tamil Nadu's Economy

Tamil Nadu, being a highly industrialized and consumption-driven state, has experienced significant impacts from GST. The state has actively participated in the GST Council, advocating for its interests. The shift to a destination-based tax system has implications for revenue collection, industrial competitiveness, and consumer prices within the state. The effective utilization of ITC and the smooth functioning of inter-state trade under GST are critical for Tamil Nadu's economic performance. The state government, through its finance department and participation in the GST Council, works to maximize the benefits of GST while mitigating any adverse effects on its revenue and industries.