The introduction of the goods and services tax (GST) has been one of the most significant shifts in India’s fiscal landscape in recent past. After being on the reform agenda for many years, it came into force in July 2017 through the implementation of the Constitution (One Hundred and First) Amendment Act, 2016, and subsequently, it was adopted by the Parliament and all the State legislatures.
This tax was expected to bring significant productivity gains to the economy with its ‘one-nation-one-market-one-tax’ model resulting in the reduction of the complexity in the tax structure and removal of the hurdles to domestic production and trade. And in terms of government revenues, it was projected to raise the total tax-GDP ratio in the medium term, ensuring increased centre transfers to states.
GST is a consumption-based tax on goods and services levied by the centre and the states. Both the central government and the state governments earn revenue from this tax. The tax revenue earned by a state government through GST includes own tax revenue and its share in the central taxes.
Own Tax Revenue
Under the GST framework, two forms of taxes are imposed in the case of intra-state supply of goods and services: the states levy and collect the State GST (SGST), and the centre levy and collect the Centre GST (CGST). Here, the GST rate on any particular supply of good or service is equivalent to the sum of the rates of SGST and CGST, and both of the rates are exactly half of the rate of GST. That means the tax collected through this by the centre and the respective state is shared equally between the two.
Further, in the case of inter-state supply of goods and services, the Integrated GST (IGST) is applied. This tax is collected by the centre and kept in a separate account. It then gets distributed between the centre and the corresponding state after the verification of the destination of the goods and services. The shared part of IGST by the state and the SGST collectively then becomes a part of states’ own tax revenue. Whereas the CGST and the rest of the IGST is added to the centre’s tax revenue.
Devolution of Central Taxes
In India, the central government has control over the majority of tax revenues, whereas the state governments are responsible for the most of economic and social services. This creates a fiscal imbalance in the system. The Constitution of India provides an institutional mechanism in the form of a finance commission for this imbalance. Article 280 of the Constitution mandates the commission to make recommendations regarding the distribution of net proceeds of taxes between the centre and the states. The first commission was formed in the year 1951 and there have been fifteen till now.
The core responsibility of the commission is to evaluate the finances of the centre and the state, and recommend the sharing of tax revenue between the two. Until the tenth finance commission, the centre and the states shared revenue gained only from income tax and union excise duty. However, after an amendment was made by the Constitution (Eightieth Amendment) Act, 2000 the centre was allowed to devolved all the central taxes (except surcharges and cess levied for specific purpose, net of collection charges) with the states.
These taxes constitute the divisible pool of taxes also including the funds collected through CGST and IGST by the central government. This division of net proceeds of taxes between the centre and the state is called the vertical devolution or vertical sharing of the taxes. Historically, the commissions have been giving recommendations for the vertical devolution of taxes. The former finance commission i.e., the fourteenth stated that since tax devolution is a formula based, it should be the primary route of allocation of resources to the states. Based on this viewpoint, it proposed sharing 42 percent of the divisible pool with the states, up from the 32 percent share recommended by the thirteenth finance commission. Recently, the fifteenth finance commission recommended the share of the states in the central taxes for 2021-26 period to be 41 percent.
After assessing the states’ aggregate share in the divisible pool of taxes or the vertical sharing of the taxes the finance commission recommends inter se allocation of this among the states. This is termed as horizontal devolution or horizontal sharing of the taxes. In the past, the finance commissions have recommended this horizontal devolution based on suitable quantitative measures or formulae. These parameters vary from time to time. Historically, these parameters were motivated by considerations of need, equity and performance. In the devolution formula, several commissions have also taken into account fiscal disabilities and fiscal discipline. However, the weightage given to each parameter has changed for each Finance Commission.
The formula of horizontal sharing of taxes is intended to emphasis on definitive goals that can be accomplished by this devolution. They are: (i) to assist in bridging the states’ vertical fiscal gap; (ii) to provide equality among the states; (iii) to account the states for cost differences in delivering basic public services; (iv) revenue equalization.
The criteria used by the fifteenth finance commission for horizontal devolution, along with the weight assigned to them is mentioned in the table given below.
|Forest and ecology||10.0|
|Tax and fiscal efforts||2.5|
- Population of a state indicates the expenditure needs of that particular state. This indicator has a vital role in equalising the impact. Since the sixth finance commission, the commissions have been using population data of the 1971 census while giving recommendations. However, the fourteenth finance commission used population data of 2011 for devolution formula. And the fifteenth finance commission followed the same.
- Area is also used as a measure in the formula because the state having the larger area would require greater administrative cost for providing services.
- Forest cover as a criterion was firstly used by the fourth finance commission since it shows that the states with significant forest covers bear the consequences of not providing enough area for other economic sectors. As a result, these states are granted a larger share.
- Income distance or distance per-capita income is a criterion that intends to equalise the devolution formula. It is calculated by finding out the difference between the state’s per capita income with the average of per capita income taken for all the states. Lower the per capita income of the state, higher the share.
- Tax effort is used as a criterion in the devolution formula to award state’s own tax results.
- Demographic performance of a state is the effort made by them in implementing various policies for improving its demographic management.
Over the years, the central government has been allocating the tax revenues to the state governments on the recommendation of the finance commission. However, with the introduction of the GST, the states have lost their fiscal autonomy, and hence increased their reliance on the system of intergovernmental transfers to satisfy their expenditure needs. Therefore, now it is the centres’ responsibility to distribute the net proceeds of taxes fairly between the two.
Author: Pratibha Maheshwari from Rajiv Gandhi National University of Law (RGNUL), Punjab.