Days after the Goods and Services Tax (GST) 2.0 rollout, Telangana Deputy Chief Minister Bhatti Vikramarka Mallu and Kerala Finance Minister K.N. Balagopal critically assessed the system, stating that GST has eroded States’ fiscal independence and needs a structural rethink. Here are key insights from their discussion:
How would you rate GST up to 2022 and after?
K.N. Balagopal: The initial five-year period of GST, ending July 1, 2022, was quite favorable. States were guaranteed a 14% annual revenue growth, which felt like a ‘honeymoon phase.’ However, once this compensation period concluded, states began facing considerable financial strain. For example, Kerala would have ideally received ₹54,000 crore last year if the promised growth was sustained, but we actually received only ₹32,502 crore. So, while GST functioned well pre-2022, its performance post-2022 would score less than 5 out of 10.
Bhatti Vikramarka Mallu: The central government promised states a 14% revenue growth, similar to pre-GST levels (14-18%). Unfortunately, after five years, we haven’t even achieved 14%, with growth hovering around 7-8%. This clearly shows that the assumption of revenue stabilization isn’t materializing. The central government must acknowledge this reality and fundamentally rethink the entire system.
The idea behind the five-year compensation period was also that the States would be able to strengthen their own tax revenue during this time and increase their independence. What went wrong there?
Mallu: That wasn’t the exact premise. The central government stated that GST would stabilize within five years, and while initial compensation would cover shortfalls, states would naturally achieve 14% growth thereafter. This hasn’t happened. Furthermore, states have lost their independent taxation powers. Pre-GST taxes like VAT, Octroi, and entertainment tax were all subsumed under GST. Apart from one or two state excise levies, states have very little control left to increase their own revenues; everything is now controlled by the Centre.
Is it fair to say that GST has made the States too fiscally dependent on the Centre?
Balagopal: According to the Fifteenth Finance Commission report, state governments bear approximately 64% of the total government expenditure nationwide, yet the Union government collects around 63-64% of all revenue. This means states are responsible for two-thirds of spending but receive only one-third of the revenue. While we share GST revenue on a 50-50 basis with the Centre, it should ideally be 60-40 in favor of states. As Mr. Mallu pointed out, the system requires serious examination. When all taxation powers are removed, and states are left at the mercy of the Union government, it’s detrimental to the country’s overall health. This isn’t just an issue for states ruled by opposition parties; every state is experiencing it. I was part of the GST rate rationalization committee for several years. Historically, detailed study reports were provided, but this time, only the Union Government’s suggestions were presented. There was no thorough analysis or assessment of the revenue impact. We estimate Kerala will suffer a revenue loss of ₹8,000-10,000 crore, and other states have their own calculations. The comprehensive national picture is missing.
The Centre says the revenue loss would be about ₹48,000 crore for this year. CM Mamata Banerjee pegs it at ₹20,000 crore for West Bengal, and Mr. Balagopal says it will be ₹8,000-10,000 crore for Kerala. What is the estimate for Telangana?
Mallu: We project a loss of approximately ₹7,000 crore. Assessments of revenue loss from rate rationalization vary widely among organizations studying taxation and GST, with some estimating ₹1.4 lakh crore and others even ₹2.4 lakh crore. The exact impact on revenues remains unclear. We raised this concern in the GST Council meeting, but a proper assessment of the revenue loss has not yet been conducted.
The overwhelming majority of GST Council decisions have been made by consensus. Does that imply that all of you agreed with the fact that the States would not be compensated?
Mallu: There are two distinct issues here. We unanimously agreed on the rate rationalization. However, regarding revenue loss, states have planned numerous welfare and developmental schemes within their budgets. A sudden drop of ₹6,500-₹7,000 crore in revenue would halt these initiatives. Therefore, we all requested compensation.
What was the Centre’s reaction when you asked for compensation?
Balagopal: The agenda included the compensation question, but it was never actually discussed. We presented our arguments and notes, but no concrete action or discussion occurred regarding a compensation cess.
Would it make more sense to increase the States’ share in Central taxes?
Mallu: Devolution is a critical issue for states. If the 41% divisible pool is distributed based on individual state contributions, that would be equitable. However, the current system collects from all states and distributes equally, causing states that generate more revenue to lose out, while others gain. Many states have requested that revenue be distributed proportionally to what is collected from each state.
What are the issues that you confront in terms of the State governments’ ambitions to have their own welfare schemes?
Mallu: Different states have unique welfare needs based on their geographical and socio-economic conditions. For example, Kashmir requires distinct schemes due to its cold climate, while southern states like Telangana, or states like Bihar and Uttar Pradesh, have entirely different requirements – perhaps more focus on education, health, housing, or shelter. States design their welfare programs to suit their specific needs. If the Indian government imposes a ‘Centrally sponsored scheme’ that isn’t relevant to a state, yet demands a 40% contribution from that state, it’s counterproductive. States should be empowered to design their own welfare initiatives.
Balagopal: Both equity and performance should be considered. Less developed states certainly need central support. However, in Kerala, where education is highly developed, receiving funds for building new schools, a ‘first-generation issue,’ is irrelevant when we already have 13,600 schools. We face ‘second-generation issues’ that require different solutions. The core problem is that the Centre collects all tax revenues, leaving states to plead for funds. We are technically supposed to receive 41% of the Centre’s divisible pool. But in practice, as the Fifteenth Finance Commission noted, around 20% of the Union government’s revenue comes from cesses and is excluded from this divisible pool. So, states effectively receive only about 30-32% of the total central revenue. If the GST continues on this trajectory, I believe it will be detrimental not just to states, but to the entire country. All states share this sentiment.
You had earlier said that, with the GST, the States would be reduced to going to the Centre with begging bowls. Has this come to pass, and can the GST continue in this manner?
Balagopal: During the GST Select Committee discussions before its rollout, I questioned why India was adopting a ‘one country, one tax’ system when even advanced nations like the U.S. do not have it, unlike the European Union, which faced issues like the Greece crisis. I dissented, predicting that state finance ministers would become mere supplicants. While states haven’t quite reached the ‘begging bowl’ stage, their dependence on the Centre has undeniably grown. We are technically entitled to 41% of the Centre’s divisible revenue, but practically, the Fifteenth Finance Commission noted that about 20% of the Union government’s total revenue comes from cesses, which are excluded from this pool. This reduces our effective share to roughly 30-32%. If GST continues this way, it will be unhelpful for the entire country, not just the states. This feeling is widespread among states.
Mallu: The dependency of states on the Centre has indeed increased with the GST system, though I prefer not to use the term ‘begging bowl,’ because all collections go to the Centre and are then disbursed to states. Furthermore, the GST Secretariat is staffed entirely by central government officials, with no state representation. This means decisions are made without equal discussion or understanding of states’ perspectives, leading to ‘utter chaos’ regarding issues like input credit. If states had representation, solutions would be more transparent and collaborative.
The Centre said a lot of the revenue foregone will be made up again because the rate cuts are going to be a huge boost to consumption and the economy. Do you agree with this argument?
Mallu: This argument has been discussed extensively, but we still need to see it translate into reality. States are immediately affected by revenue shortfalls and need to survive until increased sales and taxation stabilize revenues. Compensation for initial losses is crucial.
Balagopal: While a boom might occur as prices decrease, a market economy has two sides: supply and purchasing power. If employment is negatively affected, public spending and finances are constrained, and unemployment rises, then even if shops are stocked, who will buy the products after a certain period? If state governments have empty coffers, how can they fund spending that stimulates employment and economic activity? Without this balance, any ‘euphoria’ from rate cuts will be short-lived.