NEW DELHI - The Goods and Services Tax (GST), one of Indian Prime Minister Narendra Modi's biggest reforms, if not his biggest, has run into trouble on the back of the coronavirus pandemic and a contracting economy.
The GST, which cut down a web of taxes at the federal and state levels, was a massive political victory for Mr Modi, who, due to his majority, pulled off a reform in 2017 that previous governments had tried and failed owing to the lack of political consensus.
Now, the tax, dependent on cooperation between states and the federal government, has run into trouble with the coronavirus pandemic and low GST collections resulting in a revenue shortfall of 2.35 trillion rupees (S$43.7 billion).
Finance minister Nirmala Sitharaman announced late last month that the federal government would be unable to compensate states. Instead, she asked states to borrow the amount from the Reserve Bank of India, among other options.
Compensating states was the foundation on which the GST was negotiated because it got doubting states to agree to a revenue sharing model to make up for losing state taxes like the Value Added Tax.
The result has been strong opposition from at least five opposition-ruled states that have accused the federal government of going against the spirit of federalism and reneging on the compensation deal.
The West Bengal government has called the move a "planned strategy to crush federalism" while the Delhi government called it the "biggest betrayal" in the history of federalism in India
Kerala chief minister Pinarayi Vijayan, in a letter to Mr Modi, noted that no compensation had been released to the states since April 1 when the deal was for the federal government to transfer compensation every two months.
"It is felt that transferring the obligation of GST compensation to the states through their borrowing is not in accordance with the spirit of understanding reached between the centre (federal government) and the states," he wrote in the letter.
Under the GST Act, states were guaranteed full compensation for any revenue loss in the first five years.
This compensation was to come out of a cess on sin and luxury products, such as liquor and cigarettes.
India had one of the most stringent Covid-19 lockdowns, shutting down all economic activity when there were a few hundred cases in March.
Since April, the government has been slowly easing restrictions to push economic growth which has remained sluggish amid rising coronavirus numbers.
Latest figures show India has 4.47 million cases, and the economy contracted by 23.9 per cent in the April to June period.
Making up the shortfall would not be easy, given the state of the economy, said analysts.
"The problem has become aggravated due to a steep fall in collection of states due to Covid 19 and impact on the compensation pool with cess on luxury goods coming down. Sales of luxury cars, for example, have come down. So there is double impact and, therefore, the problem has become acute," Mr Muralidharan Ramaratnam, a senior director specialising in indirect taxes at Deloitte India.
The GST council, which controls GST and has federal and state representatives, is set to meet on Sept 19.
Indian media reports said that the federal government is working on solutions, including paying part of the compensation. But much depends on whether states accept the compensation package.
There is little good news on the collection front.
August revenues slipped around 1 per cent from the previous month to 864.49 billion rupees.
- India introduced the GST in 2017
- Unlike Singapore, India does not have one tax slab for all goods and services but four different slabs, ranging from 5 to 28 per cent
- Government faces revenue shortfall of 2.35 trillion rupees
- The states and union territories of Kerala, Punjab, West Bengal, Puducherry and Delhi are against the proposal that they borrow from the Reserve Bank of India
Many businesses have seen falling or no revenues.
"This is an ongoing problem for the centre (federal government) as the economy is unlikely to recover soon given the staggered opening of the economy; given the pandemic moving to rural areas and increased numbers," said Mr Rishi Sahai, managing director and co-founder of corporate finance firm Cogence Advisors.
Some states have suggested that tax slabs or cess rates be raised to bolster revenues. This means bringing more items to the 28 per cent slab. India has four different slabs for goods and services, ranging from 5 to 28 per cent.
They have also suggested that the federal government borrow and compensate the states.
"Ultimately the whole thing comes on us (the taxpayers). But the states are tensed, if they put a load on citizens it will put a negative effect on the vote bank. West Bengal is going to the polls soon," said Kolkata-based economist, Professor Sarthak Roychowdhury.