Resetting the GST paradigm

The roll-out of the countrywide goods and services tax (GST) from July 2017 was expected to favour the consuming states more than those with heavy concentration of manufacturing and mining enterprises. The premise of such thinking was that since the GST was a destination-based tax, states that consume more would have a larger share in the collection of the state goods and services tax (SGST), compared to the predominantly manufacturing or mining states.

However, tax revenue numbers of 17 states, which have so far presented their annual budgets for the current financial year, tell a slightly different story. These numbers, compiled by Elara Capital after an analysis of 17 state budgets, show that about eight of the states recorded lower tax revenue growth in 2017-18, compared to that in the previous year. The remaining nine states showed decent growth in their tax revenues in the same period. The tax numbers for 2017-18 should be a reasonable proxy for measuring the SGST impact on revenues, since the new tax regime was in force for three of the four quarters of the year.

The surprise is that Bihar, West Bengal, Madhya Pradesh and even Andhra Pradesh are largely consuming states, but their revenue growth has declined. Indeed, Bihar has seen a decline in its tax revenue collection in 2017-18 — a drop of about one per cent compared to a rise of five per cent in revenue collections in 2016-17. Madhya Pradesh was a little better with revenue growth of 7.5 per cent in 2017-18, compared to a higher collection growth rate of 10 per cent in the previous year. West Bengal and Andhra Pradesh also saw a drop in their revenue collection growth rates from 16 per cent and 12 per cent, respectively, in 2016-17 to 10 per cent and eight per cent in 2017-18.

Both Jharkhand and Chhattisgarh have a large mining sector attracting many new industries based on minerals. Understandably, therefore, Jharkhand’s tax revenues grew by 15 per cent in 2016-17 and dropped to just five per cent during the GST year of 2017-18. Chhattisgarh’s revenue growth fell by almost half — from 14 per cent in 2016-17 to 7.5 per cent in 2017-18. Karnataka and Telangana, which are hubs for information technology companies, have also seen a decline in their respective revenue growth rates – from 12 per cent in 2016-17 to 7.5 per cent in 2017-18 for Karnataka and from 16 per cent to 15.5 per cent for Telangana in the same period.

Going by the premise that manufacturing or mining states do not benefit hugely from a destination-based tax like the GST, this is not unusual, though it could be argued that these states also have a strong consumption base, helped by a thriving services sector, whose taxes under the GST are now being shared with them unlike in the past.

But the bigger surprise lies in the huge increase in the tax revenue growth of largely manufacturing states like Maharashtra (up from nine per cent in 2016-17 to 19 per cent in 2017-18) and Gujarat (from three per cent to 12.5 per cent). Haryana, too, saw a doubling of its revenue growth to 20 per cent and Punjab recorded a trebling of its revenue growth to 13 per cent in this period.

Contrary to what happened to Jharkhand or Chhattisgarh, the revenue growth of Odisha, a mining state that is in the early stages of industrialisation, was up from seven per cent in 2016-17 to 20 per cent in 2017-18. Rajasthan, too, almost doubled its revenue growth to 14 per cent in this period. In spite of being a manufacturing state, Tamil Nadu saw a decent rise in its revenue growth from eight per cent in 2016-17 to 11 per cent in 2017-18.

Kerala and Uttar Pradesh (UP) are both consuming states. Unsurprisingly, Kerala saw its revenue growth treble from 4.5 per cent in 2016-17 to 15 per cent in 2017-18. But UP saw only a marginal increase in its revenue growth from 12 per cent to 14 per cent in this period.

Clearly, there is no pattern in the revenue growth of these 17 states in the pre-GST year and the year when the GST was launched. These revenue trends also question the conventional wisdom that consumption states would gain more as the GST is a destination-based tax. There could be two reasons why the earlier belief may no longer be valid. 

One, the states’ ability to tax services and collect revenues from them under the new regime has certainly helped even the manufacturing states. Two, the efficiency and effectiveness of the tax administration in each of these states could be influencing such revenue outcomes. There could be no other reason why Bihar should see a fall in its revenue collections, while Kerala would record a trebling of its revenue growth.

The implications of these revenue trends are no less significant. Given the sharp rise in tax revenues under the GST regime for most states, the task of compensating states that might lose revenue after the GST is no longer looking difficult. Since the revenue loss for states will be calculated by assuming revenue growth of 14 per cent over the base year of 2015-16, it seems only a few states will qualify for such compensation. Indeed, there is a possibility that the compensation cess, now in force till 2022, may actually provide a revenue bonanza for both the Centre and the states, which will have an equal share of the undistributed cess.

A legitimate demand, therefore, will be to scrap the compensation cess before 2022 or reduce its rates significantly, so that economic activities benefit from a lower tax incidence. Remember that there is a 15 per cent compensation cess on large cars and sports utility vehicles! Such a demand will be further fuelled by the projections these 17 states have made for their tax collections during 2018-19. Barring Jharkhand, all other states in this group have projected tax revenue growth of over 50 per cent in 2018-19. Even Jharkhand is expecting its tax revenues to grow by over 17 per cent in the current year.

Clearly, all these states are bullish about tax revenues in the current year and all this is largely on account of the GST. It is possible that these projections may be a little exaggerated for some states. But if the revenue growth trends look real after stock-taking at the end of the first quarter of 2018-19, then the GST Council should consider moving goods and services to lower and fewer rates, to make the GST simpler and easier.