New Report Calls for GST Slab Rationalisation Amid High State Revenue Deficits, Subsidy Expenditures

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A new report has shed light on the status of state finances, highlighting the persistent budget revenue deficit. This, according to the report, is leading to limitations on capital outlay, specifically the allocation of funds to create assets.

The report also points out that the goods and services tax (GST) slabs need to be rationalised for the post-compensation period.

The Union government had refused to extend the original GST compensation period, which affected the states’ revenues.

The GST was introduced on July 1, 2017, and June 30, 2022 marked the end of the transition period during which the states were compensated for any loss in revenue due to the implementation of the new tax regime. This was calculated as the difference between the projected revenue based on a 14% annual growth with 2015-16 as the base year and the actual GST revenue.

The report also says that electricity subsidies form about half of total expenditure by states.

The report titled ‘State of State Finances’ was released by PRS Legislative Research, a non-profit independent research institute, on October 1 (Wednesday). It has been authored by Tushar Chakrabarty and Tanvi Vipra.

States continue to budget revenue deficit

A revenue deficit implies that the revenue generated by a state is not enough to cover its estimated revenue expenditure which includes salaries, pensions, etc.

In other words, this means that the state governments are consistently spending more money than they are generating through their regular sources of income, such as taxes, fees, and other revenue streams. Their expenses exceed their income.

This puts a limitation on the creation of assets.

The report noted that since 2015-16, seven states have persistently reported a revenue deficit. These states are Andhra Pradesh, Haryana, Kerala, Punjab, Rajasthan, Tamil Nadu, and West Bengal.

All recent Finance Commissions have recommended grants to states to eliminate revenue deficits.

The 15th Finance Commission has recommended revenue deficit grants of nearly Rs 2.95 lakh crore for 17 states over the next five years, from 2021-22 to 2025-26. Around 87% of the grants were awarded in the first three years, the report said. Therefore, the grants in the next two years will be substantially lower, and states will have to augment their revenue sources or cut expenditures to maintain revenue balance.

Kerala received the largest share of the revenue deficit grant of Rs 4,749 crore. It won’t receive any grants in 2023-24.

The report added that 11 states have budgeted a revenue deficit. Out of these 11 states, Andhra Pradesh, Himachal Pradesh, Kerala, Punjab, and West Bengal have budgeted revenue deficit after accounting for revenue deficit grants in 2023-24. If grants were not provided, six more states, including Assam, Nagaland, and Uttarakhand, would have been in revenue deficit in 2023-24.

Note that states’ own tax revenue is the largest source of revenue for them.

In 2023-24, states on aggregate are estimated to have raised 57% of their revenue receipts from their own tax and non-tax sources, while 43% is estimated to have come from the devolution of central taxes and grants from the Union government.

In 2023-24, states’ revenue expenditure is budgeted to be 83% of their total expenditure while capital outlay is budgeted to be 17%, the report added.

Rationalise GST slabs

States’ GST revenue has been consistently lower than the guaranteed revenue.

“This is because states’ aggregate GSDP has grown at a compounded rate of 9.6% between 2018-19 and 2022-23, lower than the 14% guaranteed growth rate,” the report said.

When the GST was introduced in July 2017, states were given a revenue guarantee of 14% per annum on their GST revenue over the base year 2015–16. However, not many states had a growth rate of subsumed taxes higher than 14% pre-GST, with most of them falling in the 5%–12% growth rate band, the Economic and Political Weekly reported in December 2020.

States that fell short of this annual GST revenue growth were compensated until the end of June 2022. The compensation to the states was being met through the levy of a GST compensation cess on specified goods and services. However, the end of the compensation affected their revenues.

Moreover, the 15th Finance Commission had observed that the GST’s revenue neutrality was compromised due to multiple tax rate reductions.

The GST Council had in September 2021 decided to set up a Group of Ministers (GoM) for rationalising tax exemptions and correcting the inverted duty structure (where the tax on finished or processed goods is lower than the tax on the raw materials or intermediate products used to manufacture those finished goods).

In its 47th meeting, the GST Council had recommended several tax rate changes to reduce exemptions and correct the inverted duty structure. However, the changes have not been adopted so far, says the report.

After five months, the 48th GST Council meeting, held on December 17, was a “disappointing affair”, because there was no correction of the inverted duty structure, an exercise which also led to the rationalisation of rates, Najib Shah, former chairman of the Central Board of Indirect Taxes & Customs, wrote on CNBC-TV18.

“There was no attempt either to move towards the much-debated convergence of rates,” he added.

The PRS report also highlighted that “at present, SGST accounts for over 40% of states’ own tax revenue.”

And, therefore, GST slabs may need to be rationalised to get additional revenue in the post-compensation period, it said.

Inflating subsidy expenditure

In 2022-23, states are estimated to spend 9% of their revenue on subsidies. These include electricity supply, health, education, and transportation.

A major portion of the states’ expenditure goes towards providing subsidised electricity for agriculture, domestic and industrial use, the report said.

“In 2021-22, a large share of the subsidy expenditure went towards providing subsidised electricity. Notably, 97% of Rajasthan and 80% of Punjab and Bihar’s total subsidy expenditure went towards subsiding electricity in 2021-22,” it said.

The International Monetary Fund (IMF) has noted that a substantial portion of the benefits from these subsidies may primarily reach higher-income households.

PRS conducted a case study on Punjab’s subsidy expenditure. It said that the subsidy expenditure as a share of revenue receipts has been significantly high in the state.

Between 2017-18 and 2021-22, Punjab spent 17% of its revenue receipts on subsidies. Other states, on average, spent 8%.

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