The battle of state GST compensation

India has been battling with a global pandemic and as each day witnesses a surge in the number of COVID-19 positive cases (closing on 12 lakh any day now), there are several other burning issues in the country and one of them is fiscal federalism.

The fiscal landscape of the economy was shaped in the Government of India Act, 1935 which was then used as a template for the constitution. In the Act are mentioned four different modes of taxes - levied and collected by the federal/central government, levied and collected by provinces, levied by the federal government but shared with provinces and levied by federal but retained and collected by provinces. The central government in India is responsible for providing adequate resources to the States without placing too much constraint on the Union.

For this purpose, an independent body was set up in the year 1949, known as the Finance Commission. This establishment was responsible for making recommendations to the President with respect to allocating resources and finances between the Union and State governments. Goods and Services Tax (GST) seeks to re-institutionalize a key tax system in the country while adhering to the fiscal federalism policies as enshrined in our Constitution.

The Goods and Services Tax is a unification of all the various indirect taxes like VAT, Import & Export Tax into one and the procurement of this tax is then divided amongst States. Recent reports show that there has been a ₹30,000 Crore shortfall in Goods and Services Compensation for States in the country. Moreover, the Central Government’s latest step to suspend the MPLAD ( Members of Parliament Local Area Development) Scheme and divert the funds to the Consolidated Fund of India has taken us a step closer to centralizing this country’s resources. The MPLAD funds go to the parliamentary constituencies that help in developing the local villages and remote talukas. But with the suspension in place, the funds will land in the Consolidated Fund of India and the decision to use those funds will rest in the hands of the Finance Commission.

States need to gather strong financial resources to battle and cope with the current pandemic and this requires adequate support from the Central Government in terms of compensation. It is going to take a while for the country to heal from the damage that’s come to sight during this pandemic. The process of healing, however is an arduous one and involves providing the last mile of affordable healthcare facilities for the poor and needy.

Today, the divisible pool of taxes of the Union are far from satisfactory for the States. The ratio of funds that is divided amongst the Centre and State swing in favour of the Union and come up short for the States to cope with a situation like COVID-19 effectively. The dilution of funds under the fiscal federalism setup should be restructured keeping in mind that the development of the country depends heavily on the development of each State and that is going to be possible only if each State receives fair compensation from the Union.