Model Answer
0 min readIntroduction
The introduction of the Goods and Services Tax (GST) in India, effective July 1, 2017, was a landmark tax reform aimed at creating a unified national market and boosting economic efficiency. GST subsumed a multitude of indirect taxes levied by both the Centre and the States, replacing them with a single tax. While heralded for its economic benefits – simplification of the tax structure, reduction in cascading effects, and improved tax compliance – the GST regime has simultaneously raised concerns about its impact on the States’ inherent right to impose taxes and their overall fiscal autonomy. This necessitates a critical examination of the changing nature of Union-State financial relations in the post-GST era.
Historical Context of Union-State Financial Relations
The financial relationship between the Union and the States in India has evolved significantly since independence. Initially, the Centre held a dominant position, controlling major revenue sources. The Constitution (Seventh Schedule) delineates the powers of taxation between the Union and the States, categorizing subjects under Union List, State List, and Concurrent List. However, the Centre’s share of tax revenues was disproportionately higher.
- Early Years (1950-1990s): The Centre relied heavily on planning and resource allocation through Five-Year Plans, exercising significant control over state finances.
- Constitutional Amendments: The 89th Constitutional Amendment (2003) separated mineral development funds from consolidated funds, and the 88th Amendment (2003) aimed to prevent the imposition of tax on the sale or purchase of goods outside the state.
- Finance Commissions: The establishment of Finance Commissions (FCs) – the first was constituted in 1952 – played a crucial role in recommending principles governing the distribution of tax revenues between the Centre and the States. Each FC has attempted to address the vertical and horizontal imbalances in fiscal resources.
GST and its Impact on States’ Fiscal Autonomy
The GST regime, while economically beneficial, has fundamentally altered the dynamics of Union-State financial relations. The core issue lies in the surrender of States’ taxing powers, particularly their power to levy taxes on the supply of goods and services.
- Loss of Taxing Powers: States ceded their exclusive power to tax sales and services, which constituted a significant portion of their revenue.
- Compensation Mechanism: To address the initial revenue losses, a GST compensation mechanism was enshrined in the GST (Compensation to States) Act, 2017. This guaranteed States a 14% annual growth in revenue for five years (ending in June 2022), with the Centre compensating them for any shortfall.
- GST Council: The GST Council, a constitutional body under Article 279A, was established to oversee the implementation of GST. It comprises the Union Finance Minister, the Minister of State for Finance, and the Finance Ministers of all States. While intended to be a collaborative body, the Centre often wields greater influence due to its voting power (33.33% vs. the combined voting power of all states).
- Dependence on Centre: The compensation mechanism, while providing temporary relief, created a dependence on the Centre for revenue. The end of the compensation period in 2022 has exacerbated the fiscal challenges faced by many states.
Current Mechanisms of Revenue Sharing & Emerging Issues
Post-compensation period, the states rely on the recommendations of the 15th Finance Commission (2020-2026) for their share of divisible pool of taxes.
| Aspect | Pre-GST | Post-GST (Post-Compensation) |
|---|---|---|
| States’ Taxing Powers | Independent power to levy taxes on goods and services | Surrendered to the Centre; reliance on GST Council decisions |
| Revenue Sources | Own tax revenue, share of central taxes, grants-in-aid | Share of IGST, CGST, and compensation cess (until 2022), share of divisible pool as per FC recommendations |
| Fiscal Autonomy | Relatively higher | Reduced due to dependence on Centre and GST Council |
Several issues continue to plague Union-State financial relations:
- Vertical Imbalance: The Centre continues to have a larger share of tax revenues compared to the States, leading to a vertical imbalance.
- Horizontal Imbalance: Disparities in economic development and revenue-generating capacity among States create a horizontal imbalance.
- Delayed GST Compensation: Delays in the release of GST compensation to states created significant financial stress.
- Impact of Cess: Increased reliance on cesses and surcharges by the Centre, which are not shared with the States, further reduces the divisible pool.
Conclusion
The introduction of GST, while a significant economic reform, has undeniably altered the landscape of Union-State financial relations. While the GST Council provides a platform for collaborative decision-making, the Centre’s inherent advantages and the end of the compensation period have raised concerns about States’ fiscal autonomy. Addressing the vertical and horizontal imbalances, ensuring timely revenue devolution, and fostering greater transparency in the GST Council’s functioning are crucial for maintaining a healthy and cooperative federal structure. A more equitable and sustainable financial framework is essential to ensure that States have the resources necessary to fulfill their developmental responsibilities.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.