Fall in GST revenues spells bad news for state finances

The 19-month low in goods and services tax (GST) collections in September 2019 is worrying at many levels. It is yet another confirmation of the economy slowing down – if more evidence was needed, that is. More importantly, it is going to put a tremendous strain on the finances of governments.

Much has been written about how it is going to affect the fiscal deficit of the union government. But the effect on state finances is going to be equally deleterious – in spite of state governments getting revenues from the Integrated GST (IGST) and certain states getting the proceeds of compensation cess (states whose annual revenue growth is less than 14 per cent are to be compensated the extent of the gap up till 2022).

The latest Reserve Bank of India’s (RBI) annual publication on the analysis of state budgets shows that state finances are not in the best of shape. They are certainly adhering to the fiscal consolidation target of fiscal deficit of 3 per cent of gross domestic product (GDP) – the combined fiscal deficit for all states was 2.9 per cent of GDP in the revised estimates (RE) of 2018-2019 and is budgeted at 2.6 per cent in 2019-20. However, this consolidation has come at a price – capital expenditure has suffered. From 3.4 per cent of GDP in 2016-17 it fell to 2.5 per cent in 2017-18. The RE for 2018-19 shows a slight increase to 3.1 per cent (though one needs to wait for the final figures) but the budget estimates (BE) for 2019-20 to show a drop again to 2.9 per cent.

There are two parts to capital expenditure. One is loans and advances and the other is capital outlays (actual spending on creation of assets). The trend in capital outlay is also similar – from 2.6 per cent of GDP in 2016-17, it fell to 2.3 per cent in 2017-18, went up to 2.9 per cent in the RE for 2018-19 and is set to dip again in the BE for 2019-20. What is worrying is that the bulk of the decline in capital outlay was due to cutting back on spending on roads and bridges, irrigation and energy. Capital outlays on education, health and housing also fell but to a lesser extent.

Any fall in GST revenues will see a worsening of this situation. GST accounts for close to 35 per cent of states’ own tax revenue, which itself is 45 per cent of states’ own revenue. And the bulk of expenditure commitments – both revenue and capital – is in the realm of state governments. The RBI report itself notes that “states employ more than five times more people and spend around one and a half times more than the Centre”. It also points out that public expenditure by states has a greater bearing on physical and social infrastructure which have an enormous multiplier effect on the economy.

Indeed, take a look at roads. National highways, which are the responsibility of the union government, account for only 1.94 per cent of the country’s total road network. Around 93 per cent of the rest of the network is state highways, district, rural and urban roads, all of which are within the jurisdiction of state and local governments.

And the spin-off effects of addressing the problem of roads is quite significant. Not only will building/repairing of roads generate jobs and demand for input industries, but it also has a huge indirect impact. A recent report by the IDFC Institute, ‘Infrastructure Priorities for Job Creation in India’, points out that for every 10 per cent increase in cost saving to firms because of the provision of/improvement inroads, the percentage of increase in jobs created ranges from 1.9 per cent to 5.6 per cent.

So, if the main source of revenue for states is going to fall, expenditure compression is the only way to avoid breaching fiscal consolidation targets. It is true that not all states have needed to avail the GST compensation, which means that they have been logging growth in revenue of 14 per cent and above. But this does not mean their finances are not stressed and will not be further stressed with a decline in collections. Given the committed nature of a large part of revenue expenditure (salaries, interest payments and the like), capital expenditure will suffer. The economy is at a stage when it can ill afford this.

What, then, needs to be done? Overhauling of the GST regime is needed. The complicated structure with multiple rates and classifications needs to be replaced with a simpler design. State governments will be loath to reduce rates because of the likely revenue loss. But they must acknowledge the fact that it is this complicated structure that is creating avenues for evasion and disputes. There needs to be a thorough assessment of the gains and losses of such a move.

Secondly, compliance has to be improved. Rates rationalisation will itself help in this, but making the compliance procedure simpler will push this in a big way. Deadlines for filing of annual returns are constantly being extended because of the complicated procedures involved. Over two years after GST was introduced the filing of returns is still fraught with problems. It is high time the GST Council and the member states addressed this issue. Public expenditure on infrastructure cannot be allowed to suffer. Only that will spur spending and that, in turn, will lead to improved GST collections. There is no getting away from this.

(The writer is a senior journalist and author)

The views expressed above are the author’s own. They do not necessarily reflect the views of DH.