Supreme Court's GST Decision Can Shake Up India’s Centralising Fiscal Federalism

Opposition-ruled states see the decision opening a door to put the Centre-State fiscal relations on an even keel.

The GST council started as an excellent example of true cooperative federalism.

(Photo: PTI)

The Supreme Court has ruled in the Ocean Freight case that recommendations of the GST Council have persuasive value but are not binding on the Union and the States.

This reminds the states that they have sovereign power to enact or amend the GST law in their respective states.

Article 246A of the Constitution confers legislative power on Parliament to make laws with respect to GST imposed by the Union and for IGST. State legislatures, meanwhile, have the power to make laws with respect to the state GST. GST Council, as provided for in Article 279A, can make recommendations on matters mentioned therein.

The GST Council is the most important fiscal federal institution in India after the Finance Commission.

It was envisaged and designed as a cooperative fiscal federal institution to help India clean the mess of fragmented, competitive, and highly dysfunctional goods and services tax system in the county.

The GST Council started as an excellent example of true cooperative federalism. Arun Jaitley was instrumental in building consensus on the long pending goods and services tax in the country.

All matters were discussed thoroughly and changes introduced in the proposals under consideration to accommodate concerns and suggestions of all states. States responded fabulously. The spirit of cooperative federalism pervaded the GST Council.

The complexion of GST Council changed after Arun Jaitley left. There have been acrimonious debates and forced consensus. Tax rates have been reduced without proper consultations. States were denied the mandated 14 percent growth in GST collections and loans were thrust upon them in place of due compensation.

Not only in the GST Council, the spirit of cooperation has got frayed in many other areas. There is a clear division in the approach of the Bharatiya Janata Party-ruled states and non-BJP states. No BJP state has spoken on the SC's GST judgment.

Many Opposition-ruled states, however, see the Supreme Court's judgment opening a door to put Centre-state fiscal relations on a more even keel.

India Resembles a Fiscal Federal Union After 2014

The Constitution makes elaborate legal and functional arrangements for sharing of taxes and expenditure responsibilities, making of grants and control over borrowings, which define the nature and character of the fiscal federal structure of India.

States have substantial authority in all fiscal matters – taxation, expenditures, and borrowing. Finance Commissions have built an enormous reputation for a fair and balanced sharing of central taxes.

The central government's control over states' borrowings and carte blanche in matters of providing grants for states’ expenditure programmes makes fiscal arrangements somewhat delicate.

With a fairly well-settled tax-sharing arrangement, enactment of fiscal responsibility laws by the Centre and states, the central government discontinuing loans to states, and development of a relationship of mutual trust and respect, India’s fiscal federal system was an excellent example of cooperative fiscal federalism from 2005 onward.

This started changing materially after the BJP came to the power in 2014.

The Centre has made states bear a much greater cost of centrally sponsored schemes (CSS) while at the same time attempting to characterise and pedal the CSSs as programmes of the central government.

Central funds for many CSSs are being transferred directly to the accounts of people using direct benefit transfer systems, bypassing the state governments.

States’ borrowing powers have been controlled by imposing many conditions. The states are made to demonstrate that they have complied with the conditions imposed by the Centre before the Reserve Bank of India (RBI), their debt manager, allows them to borrow.

The central government has restarted the practice of making loans to the states. In the 2022-23 Budget, the Centre laid the bait of a Rs 1 lakh crore 50-year loan at low interest rates for making states undertake capital expenditures, which the central government wants.

Many grants recommended by the 15th Finance Commission have not been agreed to or are being modified to suit the Centre's priorities.

The rates of excise duties have been raised on petroleum products and its structure changed to make more than 90 percent of excise revenues non-sharable with states.

The central government talks of a double engine sarkar to drive home the point that CSSs are best delivered when the governments in states and Centre are of the same party.

Changes in the fiscal federal architecture made in the last few years, however, have sought to make states lose their independent powers and become more of a follower of the central government.

Using the vehicle/engine simile, the central-state fiscal relations these days resemble more a tractor-trolly than a double engine.

The SC Judgment May Shake Up Fiscal Federal Structure

There are many pain points for states currently.

The GST compensation cess has been extended for five years post 2022 but for only making the payment of loans taken and the arrears of GST compensation. States are demanding a protection of 14 percent growth in SGST for five more years.

Calculations suggest that there is likely to be much larger GST compensation collection in five years from 1 July 2022 than the requirement of paying the loans taken and GST arrears. A mutually acceptable solution needs to be found on sharing of excess compensation cess revenue but there is no discussion on how to use this excess and calm states’ nerves, who otherwise anticipate a drastic hit on their finances after July 2022.

Recent acrimony on the reduction of excise duties/VAT on petroleum has kept the pot boiling.

Some states have been contemplating going to the Supreme Court to challenge the Centre’s excessive control over states’ borrowings. States’ discomfort over implementation of CSSs also needs to be resolved.

The Supreme Court judgment in the GST case may stir up states to take up these matters to defend their territory and regain lost ground. To assert their authority, some states may harden their stance in the GST Council and may introduce changes in their GST laws disregarding the GST Council's recommendations.

The GST judgment has significant potential of upsetting the tractor-trolly federalism and restoring India’s true cooperative fiscal federalism.

(The author is Chief Policy Officer, SUBHANJALI, Author of 'The $10 Trillion Dream', and Former Finance and Economic Affairs Secretary, Government of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)