GST Revenue: How to Increase Goods and Services Tax Revenue in the Post-Compensation Era

On Thursday, the Supreme Court upheld an order from the Gujarat High Court which held that the Center and the states simultaneously possess the power to legislate on goods and services tax (GST). It thus ruled that the recommendations of the GST Council could not be binding on the Center and the States.

Even with this verdict, and with the fifth anniversary of the GST approaching July 1, states continue to worry about the likely impact on their finances. With the era of assured income set to end on June 30, such concerns are not misplaced. However, as the GST is a Union and State cooperative enterprise – a fact reiterated by the Supreme Court’s ruling which struck down the central notification levying the Integrated GST (IGST) on importers for ocean freight – the Center , too, must also be concerned. Because, it can only be strong if the States succeed on the budgetary level.

Well paid

States were assured, for the first five years of the GST, of being compensated for any shortfall. This was calculated assuming a 14% year-over-year growth from subsumed base year revenue for 2015-16. The amount of compensation was not to be paid from the Consolidated Fund of India (CFI) but from the compensation fund created by levying a tax in addition to GST on supplies attracting the rate of Highest GST of 28% – on luxuries, demerits and sinful goods such as paan masala, soft drinks, coal, tobacco, automobiles etc.

According to a 2021 RBI study of state finances (bit.ly/3NpgRZ5), the average growth rate of subsumed tax collection in the three years before the GST was 8.9% for the 18 major states of non-special category. But the GST Board states negotiated a compound annual growth rate (CAGR) of 14% over seven years. The Indian government also accepted this strong growth of 14%, assuming that the GDP growth rate would also be higher.

The GST was doing well until the pandemic hit in 2020. The GST revenue, despite dropping suddenly in March 2020, had a shortfall of only ₹9,970 crore. Thus, it is clear that there were very few problems during the first three pre-pandemic years of GST. It has not recovered since the pandemic, although it is bouncing back, thanks to the multitude of measures taken by the Indian government over the past year which has seen a record monthly income of 1.68 lakh. ₹ crore in April.

From April 2020 to June 2022, the shortfall against the benchmark of 14% was forecast at ₹6.72 lakh crore. Cess revenue during this period was expected to be well below requirements, resulting in a significant gap.

It is in this context that the GST Council has decided to resort to borrowing (to finance part of the pay gap) and to extend the levy of the tax until March 2026. The entire deficit does not however, was not borrowed, and the gap – only up to 7% growth – was financed by borrowing, leaving compensation arrears.

As a result, ₹1.1 lakh crore and ₹1.59 lakh crore were borrowed in 2020-21 and 2021-22 respectively. It was decided that the levy collected during the extended period would be used for debt servicing and payment of compensation arrears.

Also, cess collection from April 2020 to March 2026 has been projected at ₹6.61 lakh crore. With the amount required for debt service being in the range of ₹3.3 lakh crore and the compensation arrears being in the same range, almost all of the tax collected over the extended period would be used to liquidate the debt and to repay the arrears of compensation.

Elastic limits

Many states have requested an extension of compensation – ignoring the fact that the levy period has already been extended to March 2026 and that any tax collected during the extended period will be used for debt servicing and payment of arrears. There is very little room to expand the levy of the tax. Moreover, revising the tax rates is not a viable option, since the collection of the tax has already reached a saturation level, and any further increase could well prove counter-productive.

However, states will find it difficult to live with the 14% growth scenario that they will have experienced with the GST. They are looking at a discrepancy of almost ₹1 lakh crore on this account in the current financial year on a cash basis. A gap of this order should persist in the absence of sustained fiscal effort.

This is where the GST Council will apply. Options are limited, especially in the wake of the global global economic order, the war in Ukraine and soaring crude prices. Any major overhaul of the path of GST rates may not be feasible, especially when the economy is just beginning to recover.

What can be done, however, is to undertake a review of exemptions which will help broaden the tax base and allow a flow of credit. Tariff rationalizations can also be undertaken to remove barriers to domestic industry.

The biggest step it can take, however, is to streamline the tax administration process to further plug leaks. As a result, auditing and reviewing returns based on risk analysis is sure to pay dividends. Other checks and validations in the registration regime can be put in place to prevent fraudsters from entering the system.

The return process can be further streamlined to ensure payment for admitted liability and to prevent tax credit misuse and fraud. These measures are sure to have a salutary effect on the compliance environment and will strengthen revenues.