UNDERSTANDING FISCAL FEDERALISM
Fiscal federalism is economic counterpart of Political Federalism. Fiscal Federalism consists of 2 aspects:
- Assignment of functions to different levels of Governments
- Allocation of financial powers
NEED TO HAVE PERMANENT FINANCE COMMISSION
- Finance Commissions have adopted different approaches with regard to principles of tax devolution, grants to be given to states and fiscal consolidation issues.
- Even though, there has to be freedom for fresh & innovative thinking by every Finance Commission; at another level, there is a need for broad consistency between Finance Commissions so that there is some degree of certainty in flow of funds to states.
- For example, 14th Finance Commission has provided for tax devolution of 42% as compared to 32% provided by 13th Finance Commission. Further, 14th Finance Commission has added parameters of Area under Forests and Demographic Change (2011 census) for the horizontal tax devolution. Fiscal discipline parameter used by 13th Finance Commission has been done away with by 14th Finance commission.)
NEED TO STRENGTHEN NITI AAYOG
Vijay Kelkar is of opinion that the present mechanism of setting up of Finance Commission every 5 years is working perfectly fine. However, there is a need to strengthen fiscal Federalism by empowering NITI Aayog with transfer of finances.
Rationale
- Planning Commission was involved with transfer of finances to the states which to a certain extent were able to reduce the regional imbalances existing among different states in India. However, Planning Commission was replaced by NITI Aayog, which acts more like a think tank without power of transferring finances.
- Two problems have arisen with this. Firstly, India’s Fiscal Federalism stands only on one pillar, viz., Union Finance Commission. This is a serious weakness of our present Fiscal Federalism and needs to be corrected.
- Secondly, India has been experiencing process of “Conditional Convergence” amongst different States wherein poorer states have been growing more rapidly than richer states leading to reduction in income inequality. Such conditional convergence has been possible on account of transfer of finances by Planning Commission.
- Thus, there is a strong case for strengthening the role of NITI Aayog with powers of allocating finances to states. To make the new NITI Aayog more effective, it is essential to ensure that the institution is at the “High Table” of decision making of the Government. This means the Vice Chairman of the new NITI Aayog will need to be a permanent invitee of the Cabinet Committee on Economic Affairs. Thus, new NITI Aayog will make available to the highest level of policy making knowledge-based advice and provide national and long-term perspective on the policy proposals.
- TENSIONS IN FISCAL FEDERALISM: POOR FINANCES OF STATES
EROSION OF FISCAL AUTONOMY OF STATES UNDER GST REGIME
- With the advent of the GST regime, States surrendered the power to levy many taxes. Ex: state sales tax, octroi, Entertainment tax etc.
- State governments cannot change the rates of GST on their own according to their fiscal needs.
- Loss of revenue to the manufacturing states since GST is a destination-based tax.
Decline in the share of own tax revenue from 69% in 1955-56 to 38% in 2019-20.
Delay in payment of GST compensation to states.
States share in overall tax revenues has stagnated because the non-divisible pool of cesses and surcharges has been increasing.
Union government lays down several conditions to increase the borrowing limits of the state governments.
Lack of financial and operational autonomy in implementing Centrally sponsored schemes.
STEPS TO STRENGTHEN FISCAL FEDERALISM
Flexibility should be given to the states to increase tax during crisis. Ex: Kerala government was allowed to levy 1% Calamity cess on GST to reverse the devastation caused by the floods
Flexible borrowing limits for fiscally prudent states, which have not breached FRBM limits and managed overall debt at sustainable levels.
PERFORMANCE ANALYSIS OF GOODS AND SERVICES TAX (GST)
New GST system was implemented from July 2017 to replace several central and state taxes on same base with a country-wide common framework. As each State levied its own VAT, tax system was fragmented with different rates being applied for comparable sales of goods.
OUTLINE OF GST SYSTEM
Legal Framework: Legal regime of GST includes four Central laws (Central Goods and Services Tax (CGST) Act, Integrated Goods and Services Tax (IGST) Act, Union Territories Goods and Services Tax (UTGST) Act and Goods and Services (Compensation to States) Act along with twenty-four state laws, relevant State Goods and Services Tax (SGST) Act
Policy Framework: GST system is based on a system of multiple rates to various categories of sales (0%, 5%, 12%, 18%, 28% and additionally 0.25% for precious stones and 3% for gold).
Tax Administrative Framework: Administration of GST is done in parallel by Central and State GST administrations with powers to audit and administer shared. To support the administration of taxpayers, a common nation-wide IT backbone called the GST Network (GSTN) has been put in place through which all tax returns are required to be filed.
POSITIVES: Done away with Cascading effect of Tax on Tax + One Nation One Tax + Improved Tax Compliance + Increase in number of registered taxpayers + Lower cost of Goods and Services + Improvement in Ease of Doing Business
ISSUES IN GST IMPLEMENTATION AND FUNCTIONING
15th Finance Commission has highlighted some challenges with the implementation of the Goods and Services Tax (GST). These include:
Stagnation in Revenue: Monthly GST collections crossed Rs 1 lakh crore in April 2018 and since then have remained stagnant.
Inverted Duty Structure refers to a situation where the rate of tax on inputs purchased (i.e., GST Rate paid on inputs) is more than the GST rate on finished goods. The inverted duty structure leads to higher input tax credits and hence lower tax collection for the Government.
Complexity: GST was introduced to simplify the tax structure and improve the tax compliance. However, the existing GST regime has multiple rates: 0, 0.25, 1, 3, 5, 12, 18 and 28%.
Coverage: Petroleum crude, petrol, high speed diesel, Aviation Turbine Fuel (ATF), Natural gas etc. are still outside GST.
Issues in Refunds: Delays in GST refunds, recent unearthing of fake invoices and fraudulent practices to corner input tax credit.
Anti-profiteering framework: Need to evolve clear guidelines on anti-profiteering mechanism.
Shortfall in GST Compensation CSS: Almost 21 states still depend upon Centre for the GST compensation.
Lack of Revenue Neutrality: A change in tax structure is revenue neutral if the modified tax is able to realize revenue comparable to the original tax regime. In this sense, the much-needed revenue neutrality of GST stands compromised. The Share of General Government’s revenue from taxes subsumed under GST was 6.3% of GDP in 2016-17. However, collections under GST were 5.7% of GDP in 2018-19 and 5.6% in 2019-20.