First, the trust-deficit between the central and the state governments was bridged over by finance minister P Chidambaram through his announcement of the intention of the central government to fully compensate the states for phasing out central sales tax (CST). With this announcement, the finance minister has set in motion the process of sorting out one of the most contentious issue that was creating a road block in the introduction of GST.

Second, the announcement of the setting up of sub-committees for design, compensation, threshold, dual control, etc, has facilitated the movement towards GST.

Third, the emergence of a consensus on an aligned exemption list is a very welcome step. The Centre has finally agreed to prune its current exemption list of around 243 goods under Cenvat to only 96 under the state-VAT. This ensures that only a few items remain outside the GST net. Similar alignment is also needed for services and this will entail a re-look at the ‘negative list’.

Fourth, consensus has emerged to have an exemption limit of R25 lakh for dealers under state GST and R1.5 crore for dealers under central GST. Thus, the large dealers would be under dual control of both the Centre and the states while it is the states that will collect the tax for dealers having a turnover up to R1.5 crore. However, as pointed out by some smaller states such as Himachal Pradesh, Uttarakhand and some in the Northeast that most of their traders would escape the tax at that limit, it is therefore important that this should be left to the state concerned.

The states will be free to opt out of GST. This partial implementation of GST has been allowed mainly for political reasons rather than design considerations. Some states are virulently opposing GST and this will require a system where we can move forward without them. Ideally, all states should join GST together. However, in a last effort to take all states on board and to make the states ‘virulently opposing’ GST to get a ‘good’ feel about it, the decision taken at the recent meeting at Mussoorie to take the state finance ministers to South Africa is a welcome step. Let all the states see for themselves how GST can be best administered in India. This might help to get consensus from amongst those states currently opposing GST.

Finally, the reports of the sub-groups were discussed at the recent meetings of the EC. The new design of GST will have a 11% rate for the Centre and 13% rate for the states, along with a band of rates—a floor rate and a ceiling rate—within which the states are free to have a high rate when needed. It is, however, important to point out that the band has been agreed to allow states’ autonomy in case of any fiscal crisis, viz drought, earthquake, etc, when they will need to generate more revenue. It is not seen as an automatic right of the states to utilise the band from day one. Initially, all states will operate from the bottom of the band and will get compensation from the government of India, accordingly.

Since the Centre is going to compensate the states, it is important to see how the revenue-neutral rate (RNR) is estimated and how the estimation of GST revenue is attempted.

In calculating RNR, it is important to keep in mind that the proportion of CST will vary amongst different states. The existence of purchase tax, entry tax and other related taxes would have an impact on RNR. Hence, the loss of revenue to different states would also vary. Also, the estimation of loss of revenue would depend upon the methodology being followed to estimate it.

While there are different methods for estimating revenue, adoption of a particular method depends upon the availability of data. Three approaches could possibly be used, viz revenue approach, turnover approach and the consumption approach for estimation of potential revenue.

Revenue approach is based on the trends in the yield of the tax. The data for aggregate revenue and the commodity-wise revenue could be obtained from the Budget Documents, the Directorate General of Data Management Centre and the Tax Research Unit of the Union Government. Data on other variables are available with the CSO. Taking into account the availability of data, the revenue approach could follow three different variants, viz growth rate method, buoyancy method and tax-GDP ratio method.

Turnover approach is based on actual and projected turnover of commodities that yield revenue to the Centre and the states. Owing to lack of availability of data on turnover from the states, this approach can be used for estimating trends of revenue for central taxes only.

Consumption approach uses macro data on consumption expenditure and capital formation. This includes private final consumption expenditure and the government final consumption expenditure on commodities and government expenditure on capital formation.

Revenue from services can be estimated first by using the available CBEC data on yield from services under the tax net. Revenue from services that have been so far untaxed is estimated through the consumption approach.

Based on the above approaches, estimation of revenue for the Thirteenth Finance Commission from the current rates—by CBEC for Cenvat and Service Tax and from the present base of state-VAT and related taxes, for the states revenue indicates that the projected revenue from the proposed GST with 8% RNR (with lower rate on some commodities) will not be substantial.

It is interesting to note that using the turnover approach (for goods) and consumption approach (for services) at the central level, the CGST revenue would almost be the same as that in the initial year. Similar is the case with the states. In the case of the states one could follow revenue approach (tax-GSDP ratio) for goods and consumption approach for services. Following this approach the estimated revenue would be almost at the level of the current projected revenue for all the major states. The situation might be different for special category states.

In estimating revenue from the current system of Cenvat (if it remains unchanged) and from the proposed system of CGST it is important to note that it is assumed that the structure of the Indian economy during the forthcoming years would be more or less stable. The economy is expected to grow at a faster rate as compared to 6-7% per annum in the past. It is also expected that the proposed GST will have better tax compliance, improved transparency and greater mobilisation due to scientific risk management policies adopted by the states. It is also envisaged that greater integration of the Indian economy with the world economy would make an impact on the overall trends in the tax revenue. Further, the integration of the Indian economy coupled with development of the economy will result in compositional change in the basket of GDP and composition of consumption.

Given the above exercise, it is clear that the Centre would have no major problem in compensating the states for any revenue loss on the introduction of GST. In addition, the Centre has already asked the Fourteenth Finance Commission as one of the Terms of Reference to keep in mind the loss of revenue due to the introduction of GST.

To conclude, the developments in the last few months could certainly be viewed as positive step towards introducing GST. However, the first and foremost step now is the passage of the Constitutional Amendment Bill in both the Houses of Parliament which requires a two-thirds majority in Parliament and then getting half the states legislators to ratify this. If necessary, the central government must call an all-party meet to evolve consensus on some of the unresolved issues pertaining to the Bill.