On Tuesday, the Goods and Services Tax Council wrote to the states informing them that it was unlikely to be a position to pay the full share of the Goods and Services Tax compensation due to them. This news came even as the states are yet to receive compensation for the months of August and September.

GST compensation was part of a compact worked out by the Modi government and the states in 2017 when the new regime was introduced to replace the patchwork of indirect taxes that existed at the time and to improve tax compliance. It was a quid pro quo for states agreeing to give up their constitutional powers to impose sales tax on goods sold within their territories. Given that many states were reluctant to do so, the Modi government agreed to generous terms, assuming that revenues of the states would grow by 14% every year.

The reality turned out to be quite different. The new tax regime not only performed worse that expected, it also collected less money that the old tax regime, which had been replaced for ostensibly being too inefficient. Moreover, GST hit India’s informal and small business sector hard. As a result, GST was one of the main causes of the current economic slowdown, pummeling an economy already hurting by demonetisation. This slowdown led to a further drop in tax revenues – including the GST.

Ironically, rather than suffer for its own mistakes in bringing in the GST, the Modi government is now looking to penalise the states by depriving them of the compensation promised to them. The 33-member Bharatiya Janata Party-controlled GST council, which has been set up to enact rules and revise rates for the scheme, would rather cut compensation due to states than make the Centre deal with the problem of falling revenues.

If GST compensation is denied to the states, this would be a serious blow to rule of law. Compensation was a key condition to get states to agree to the GST regime and the Goods and Services (Compensation to States) Act to implement it was duly passed in Parliament. For the GST council to now turn away from the law is a brazen violation.

Self-defeating move

The move would also damage the idea of federalism. The Constitution has carefully demarcated areas in which the Centre and states can work. To make this system function, states are promised revenues due to them from the pool of taxes jointly collected by the Centre as well as by other states. If tax monies are now arbitrarily denied to states, it would lead be a direct hit to this constitutional scheme.

Finally, in an economic slowdown, choking states of funds is self-defeating. In the Indian scheme of federalism, states are responsible for most of the development work. That is the last thing to cut off when Indians are facing economic distress.

State governments now do most of the heavy lifting when it comes to capital expenditure, or investing in infrastructure. As of 2018-’19, India’s states outspend the Union government by nearly three times when it comes to capital expenditure. Given that private spending is shrinking, experts have recommended an increase in government investment in order to break the slowdown spiral. However, with states being squeezed by the Centre, chances of government-led investment saving the day become even dimmer.

Any way one cuts it, the Centre’s decision to deprive the states of their GST dues is bad news for India.