GST and fiscal federalism

INTRODUCTION   

Federalism is essentially a two-party system in which several States and the federal government coexist. One of the cornerstones of the Indian Constitution’s Basic Structure is federalism. “K.C. Wheare, a federal theorist, has maintained that the Indian Constitution is quasi-federal in nature.”[1] “Articles 245 of the Indian Constitution”[2] to “Article 254 of the Indian Constitution”[3] outline the legislative authority of the Union and the states, respectively.

 “GST”[4] is defined as any tax on the provision of products, services, or both, excluding taxes on the supply of alcoholic liquor for human consumption in “Article 366(12A) of the Indian Constitution”[5]. With the ratification of “The Constitution (One Hundred and First Amendment) Act, 2016”[6] on September 8, 2016, the country’s indirect tax system became unitary and the states lost a great deal of their sovereignty. State governments lost their autonomy to levy taxes after the GST was implemented in 2017. Because they are exempt from the GST, alcohol and petrol remain the two main ways that states can continue to raise their own taxes without requesting permission from the federal government.

The tenuous “compensation guarantee,” which required states to give up their fiscal authority in exchange for guaranteed revenues, is what keeps India’s GST together. With its inherent flexibility, the Goods. and Services Tax (GST) has been implemented in more than 160 nations. It has also been stated that designing and implementing GST is a difficult undertaking in nations with federal constitutional systems. In the Indian context, the states viewed GST with great concern because they believed it would play a key role in robbing them of their autonomy, which was seen as necessary for India to continue being a federal democracy.

This article essentially aims to shed light on the intricate relationships between fiscal federalism and GST. Additionally, the goal of this study is to provide insights into possible areas of policy intervention and change in order to improve the effectiveness and inclusivity of the GST regime within the larger context of fiscal federalism and to delve into the constitutional principles, statutes, judicial precedents, and administrative practices that shape the relationship between the central and state governments concerning fiscal matters, particularly focusing on the GST regime.

HISTORICAL BACKGROUND

The earliest talks of a comprehensive consumption tax system emerged in the United States in the early 1900s, which is when the idea of Goods. and Services Tax (GST) initially emerged. Nevertheless, the concept didn’t really take off until the later part of the century. The concept of a goods and services tax (GST) began to gain traction in the 1980s as nations looked for more effective ways to increase income and streamline their tax structures. In 1991, Canada became one of the first countries to introduce a modern GST. New Zealand implemented its own version of the Goods and Services Tax (GST) in 2000, replacing an intricate sales tax system and streamlining tax administration. Australia likewise enacted a GST at about the same time, drastically altering its tax structure. As GST became more widely accepted, nations including Singapore, Malaysia, and India began enacting their own versions of the law.

India’s journey towards a Goods and Services Tax (GST) is remarkable in its scope and intricacy. The Atal Bihari Vajpayee government first proposed the concept of a GST in 2000, but it took more than ten years of political discussion and negotiations between the central government and the states for the Goods and Services Tax to be finally introduced. In the context of constitutional law, the GST required significant amendments to India’s federal structure. It involved intricate negotiations between the central and state governments to delineate powers and responsibilities regarding tax administration. The “101st Constitutional Amendment Act, 2016”[7], facilitated the implementation of GST by empowering both the central and state governments to levy and collect GST concurrently. In the context of constitutional law, the GST required significant amendments to India’s federal structure. It involved intricate negotiations between the central and state governments to delineate powers and responsibilities regarding tax administration.

RESEARCH OBJECTIVE

This study aims to critically analyse how the implementation of the Goods and Services Tax (GST) will affect fiscal federalism in the context of constitutional law. The research endeavours to provide a thorough examination of the relationship between GST and the constitutionally defined concepts of federalism, as well as an assessment of the effect GST has on the division of fiscal powers between the federal and state governments. The study aims to offer insights into the changing dynamics of fiscal federalism post-GST implementation by examining legal precedents, legislative intent, and jurisprudential perspectives. It also identifies opportunities, challenges, and potential paths for policy reform within the constitutional framework.

LITERATURE REVIEW

1. “Jha, R., & Sarangi, S. (2017). The Goods and Services Tax (GST) in India: An Overview and Interpretation. In India: Restructuring Local Governance and Fiscal Federalism ( 121-144). Singaporean Springer”[8]-A thorough review of the development and application of GST in India is given in this chapter. It looks at how the Goods and Services Tax (GST) has affected India’s federal system, with particular attention to the GST Council’s role in setting tax rates and the distribution of revenue between the federal and state governments.
2. “Debroy, B., & Bhandari, L. (2017). Impact of Goods and Services Tax (GST) on Indian Economy. Journal of Social and Economic Development, 19(2), 197-209”[9]: The economic effects of GST on India are examined in this article, along with how it affects federalism. Since state governments are no longer able to determine their own tax rates, the authors contend that the GST has diminished their economic autonomy. They do point out, though, that the GST has increased tax harmonization and decreased tax evasion, which may eventually help all tiers of government.
3. “Ganguli, B. (2018). GST and Indian Federalism: A Review of Issues and Challenges. In The Political Economy of Contemporary India (pp. 97-113). Palgrave Macmillan, Cham”[10]: This chapter offers a critical analysis of how the GST has affected Indian federalism. The author contends that the GST has caused the GST Council to become a more powerful body, potentially undermining the idea of fiscal federalism. The author does point out that GST has the ability to lower trade barriers between states and advance economic unification in India.
4. “Prasad, A. (2018). Goods and Services Tax (GST) and Indian Federalism. In Federalism in Asia (pp. 39-50). Springer, Singapore”[11]: “This chapter compares and contrasts the effects of GST on Indian federalism by examining the experiences of other federal nations, including Canada and Australia. The author contends that the GST Council’s capacity to uphold cooperative federalism and strike a balance between the interests of the federal and state governments would determine if the GST is a success in India.”

WHAT IS FISCAL FEDERALISM

The American economist Richard Musgrave, who was born in Germany, coined the phrase “fiscal federalism”[12] in 1959. Fiscal Federalism is concerned with determining which functions and instruments are best suited for decentralized levels of government and which are best suited for centralization, according to Wallace E. Oakes’[13] 1999 definition. This idea is applicable to all three types of government: federal, confederal, and unitary. Goods and Services Tax (GST) and fiscal federalism are intertwined concepts that have significant implications for constitutional law, particularly in federal systems like India. Let’s break down the analysis of GST and fiscal federalism in the context of constitutional law

• The common starting point is that local governments have access to more thorough information than any other level of government about the preferences and local requirements of their constituents, and as a result, it is in their best interest to provide many public goods and services to their inhabitants. This generally implies that public goods and services should be provided by the lowest level of government. On the other hand, the popular wisdom holds that since macroeconomic stabilization and redistribution serve national interests, they should be predominantly entrusted to higher levels of government, such as the federal government.
• The second step is to decide how to finance a specific level of public goods and services. The first is that whichever level of government is in charge of providing a certain good or service, should also be in charge of financing it and raising the required funds. The implementation of the Goods. and Services Tax (GST) resulted in the Centre and the states sharing jurisdiction over things pertaining to the administration of the new tax, particularly in areas like policy making, rate fixing, drafting laws and rules, etc. This is sometimes mentioned as a “limitation on the powers of the states” Debroy said[14].

GST And Its Impact on Indian Federalism

Effects of the Goods. and Services Tax on the Union’s and the States’ Power Assignment The power dynamics between the Union and State governments have been significantly impacted by the introduction of the Goods. and Services Tax (GST) in India.

Some of the key changes in the distribution of powers are as follows:

• Tax administration has become more centralized as a result of the introduction of the Goods and Services Tax. The GST Council, which is made up of delegates from the Union and State governments, is in charge of overseeing the GST. The Council is a key player in determining the GST tax rates and other relevant issues. As a result, tax administration—which was formerly managed by the States—has become more centralized.
• Tax-levying authority of the Union government: The Goods and Services Tax. (GST) has given the Union government the ability to impose taxes on goods and services that were previously the province of the States. As a result, the Union government now has more taxing authority.
• States’ role in decision-making: The States have a voice in the GST Council, even in spite of the centralization of tax administration. This has guaranteed their involvement in the process of making decisions, which has contributed to the preservation of India’s federal structure.
• Constitutional amendments: A number of constitutional changes were necessary in order to establish the Goods and Services Tax (GST), and these changes have affected the division of powers between the Union. and State governments. The Union government now has more authority to impose taxes on goods and services thanks to these modifications.

COOPERATIVE FEDERALISM

The nation’s welfare and economic growth are guaranteed in an equal and equitable manner by a cooperative and competitive attitude. The ascent of the Indian economy globally can only be fortified by a customized strategy centred around collaboration and rivalry. In a ruling that cited the spirit of “Cooperative Federalism” for democracy’s well-being, the Supreme Court recently ruled that the Union. and State legislatures have “equal, simultaneous and unique powers” to enact laws pertaining to the Goods and Services Tax (GST) and they are not bound by the GST Council’s recommendations. The Gujarat High Court’s determination that the Center cannot impose the Integrated Goods. and Services Tax (IGST) on ocean freight from Indian importers was upheld by the Supreme Court in its decision. To put it simply, the GST gives Parliament and State Legislatures concurrent legislative authority. By sharing powers, the objective was to achieve uniformity and streamline the taxation system, ensuring a seamless flow of goods and services across state borders.

The cooperative federalism principle was emphasized by the inclusive approach used in the creation of the GST laws. The GST legislation was established with active participation from all states and the Centre, yielding numerous noteworthy features:

• Harmonization of GST laws: The involvement of all stakeholders led to the alignment of GST laws across the country, minimizing variations and ensuring consistency in tax administration.
• Common Definitions: Standardized definitions were established for various terms and concepts, promoting clarity and uniform interpretation of tax provisions nationwide.
• Common Procedures/Formats: Uniform procedures and formats were adopted for tax filings, invoicing, and compliance requirements, simplifying the tax administration process for businesses and taxpayers.
• Common Compliance Mechanism: A uniform compliance mechanism was implemented, enabling taxpayers to fulfil their tax obligations consistently across different jurisdictions.

“Vertical And Horizontal Distribution Of Revenue Among The Union And States”

The following elements can be used to analyse the impact:

• Increased revenue collection: Both the Union and State governments have seen an increase in revenue collection as a result of the introduction of the GST. The Ministry of Finance reports that for the fiscal year 2020–21, a total of Rs. 12.71 lakh crore was collected under the Goods and Services Tax.
• Vertical revenue distribution: The Finance Commission decides how much revenue is split between the Union and the States. A constitutional authority that makes recommendations about how taxes should be divided between the Union and the States is the Finance Commission. The vertical revenue distribution has been impacted by the introduction of the Goods and Services Tax (GST), as the Finance Commission’s recommendations determine how the GST money is divided between the Union and the States. The States should get 42% of all tax revenue, including GST revenue, according to the recommendation of the Fourteenth Finance Commission.
• Horizontal revenue distribution: The States’ horizontal revenue division has been impacted by the introduction of the Goods and Services Tax (GST). The allocation of the GST revenue among the States is determined by a set of regulations that consider many factors, including the population of each State. The States now divide revenue more fairly as a result of this.

As a result, the Union and State governments in India have collected more money as a result of the introduction of the Goods and Services Tax (GST). The Commission of Finance decides how much money goes to the Union and the States, and the introduction of the Goods and Services Tax (GST) has affected both the vertical and horizontal distribution of revenue.

The Doctrine of Pith & Substance and GST:

As mentioned before, the GST Law clearly delineated the federal government’s and the states’ respective taxing authorities. Articles 245 of the Indian Constitution”[15] to  “Article 254 of the Indian Constitution”[16] specify how the legislative authority is allocated among the several branches of government. To minimize the concerns of overlapping and double taxes, the Concurrent List does not contain multiple tax items.

“However, the GST regime differs significantly from this constitutional framework. The judiciary has developed a number of guidelines over time for assessing legislative competence. The notion of pith and substance is the most often used test in India. It stipulates that the taxable event and the incidence of the levy, or the true nature and character of the levy, must be considered while evaluating the legitimacy of a charge. Regardless of the official name of the tax, the Court must ascertain its true character before taking any other factors into account. Second, the legal term for the taxable event or incidence of levy upon which the tax is imposed. The nature of the imposition or the taxable event for which the levy is intended is a crucial component of a tax statute. When it comes to the interpretation of tax entries, rules that apply to non-tax entries apply mutatis mutandis. Tax entries should be examined closely for legislative trespass using the same standards of content and pith. The Union and the States are able to impose taxes “concurrently” since Schedule VII lacks a clear legislative entry for GST, rendering the pith-and-substance criterion moot.”

“According to the Canadian Doctrine of the double aspect theory, which holds that legislation can have two aspects — for the federal government and each state—subjects listed under Union List can also be listed under State List under a different aspect. Regardless of the Double Aspect theory, a discrete taxable event is still required to be present. The GST regime does not have a specific taxable event defined. Taxable events under GST are defined as “supply of goods and services,” and it is made clear in this act that GST can be levied by both the State and Union simultaneously on both intra-state and international sales. Even though the Constitution does not explicitly prohibit double taxation, the taxable event must be distinct. The term ‘supply’ does not have a specific meaning. A definition of ‘supply’ is needed to establish the taxable event, as the statutes still define ‘goods’ and’ services’. In light of this sweeping definition, the primary taxable event would include supplying any goods or services. It is well-established that a tax’s legitimacy might be jeopardised if a component’s definition is unclear.”

“Consequently, the current GST regime is fundamentally a drastic shift from the former constitutional structure of taxing entry. It is well-established legislation that the state has unlimited taxing authority. In the event of a conflict between the federal units, will the GST council, as a “recommendatory” body, enforce state compliance or will we have 29 rates of GST, contradicting the principle of “One Nation One Tax?”

JUDICIAL PRECEDENTS

“Union of India & Ors. Vs VKC Footsteps India Pvt Ltd.”[17]

According to “Article 279A (6)”[18], the GST Council’s operations must be governed by the creation of a unified national market for goods and services as well as a unified framework for the goods and services tax. Cooperative federalism relies heavily on this emphasis on harmony. It emphasizes that both parties to a federal arrangement—the States and the Union—must be led by the overriding desire to maintain unity when they come together for the first time to adopt the same event for taxation. The foundation of harmony is balance and acceptance of one another’s existence. The harmony concept does not require perfect coincidence in every point of reference or comparison. Cooperative federalism bases its postulate of harmony on the ideas of equality, reverence, and mutual cohabitation among coexisting groups.

“Union of India v. Mohit Minerals”[19]

The Supreme Court ruled that IGST should not be applied to the ‘service’ portion of CIF contracts between Indian importers and foreign shipping lines if IGST has already been paid on the ‘composite supply’ involving goods, transportation, and insurance. This levy on the ‘service aspect’ was deemed to violate the principle of ‘Composite Supply’ as per CGST laws. The court clarified observations on GST Council recommendations, emphasizing their collaborative nature rather than binding authority, aligning with the objective of cooperative federalism and harmony between constituent units of India as indicated by the Constitution Amendment Act 2016.

CONCLUSION

The division of authority. between the Indian Union and State governments has been significantly impacted by the introduction of the Goods and Services Tax (GST). The purpose of the GST. The council’s establishment was to supervise the execution of the GST and offer a forum for cooperation between the Union and State governments about tax-related issues. Both the Union and State governments have seen an increase in revenue collection as a result of the introduction of the GST. According to the Finance Commission’s recommendations, the Union and the States split the GST revenue. Federalism in India has been impacted by the difficulties encountered in implementing the Goods and Services Tax (GST), including cooperation between the Union and State governments, the deployment of technological infrastructure, the imposition of numerous tax rates, and the effects on small enterprises.

The introduction of the Goods. and Services Tax (GST) has presented obstacles as well as chances to reinforce India’s federal structure. These opportunities include facilitating interstate trade, simplifying the tax code, raising money for state governments, and fostering cooperative federalism. For the GST Council to preserve the federal structure, it must be adaptable enough to make changes based on state requirements. A high degree of coordination between the federal government and the states would be necessary for the GST to be successful. The mistrust between the political parties in the GST Council is a threat to the Council’s ability to function. The way the regime interprets lists deviates significantly from accepted legal norms. The statute now lacks a judicial test of substance and pith due to the addition of a new constitutional section.

In order to gain a better understanding of the possible outcomes of introducing the GST gradually, the government ought to have attempted to execute the tax in stages. To sum up the consequences of Indian federalism and the rollout of the.GST underscore the necessity of efficient revenue sharing, sustained cooperation between the Central and State governments, capital expenditures for technology infrastructure, simplification of tax rates, and assistance for small enterprises. In addition to addressing the difficulties encountered during the GST’s implementation, the government must endeavour to take full advantage of the chances presented by the law to fortify India’s federal system.

Reference(s):

[1] “Burgess, Michael, ‘2 Kenneth C. Wheare and the Federal Principle’, In Search of the Federal Spirit: New Comparative Empirical and Theoretical Perspectives (Oxford, 2012; online edn, Oxford Academic, 24 Jan. 2013), https://doi.org/10.1093/acprof:oso/9780199606238.003.0003, accessed 29 Mar. 2024”

[2]“<The Constitution of India>, § <Section 245>, Acts of Parliament, <1950>.”

[3]“<The Constitution of India>, § <Section 254>, Acts of Parliament, <1950>.”

[4]“Goods and Services Tax”

[5]“<The Constitution of India>, § <Section 366>, Acts of Parliament, <1950>.”

[6] “The Constitution (101st) Amendment Act, 2016 allows both the centre and states to levy the Goods and Services Tax (GST).”

[7] “The Constitution (101st) Amendment Act, 2016 allows both the centre and states to levy the Goods and Services Tax (GST).”

[8] “[Jha, R., & Sarangi], [The Goods and Services Tax (GST) in India: An Overview and Interpretation. In India: Restructuring Local Governance and Fiscal Federalism] [pp. 121-144]

[(2017)].”

[9] “[Debroy, Bibek, and Laveesh Bhandari]. [“Impact of Goods and Services Tax (GST) on Indian Economy.” Journal of Social and Economic Development] [19],[ no. 2 (2017): 197-209].”

[10] “Biswajit Ganguli, GST and Indian Federalism: A Review of Issues and Challenges, in The Political Economy of Contemporary India 97-113 (2018).”

[11] “A. Prasad, Goods and Services Tax (GST) and Indian Federalism, in Federalism in Asia 39-50 (2018) (Springer, Singapore).”

[12] “Shah, A. and J. Kincaid (eds.) (2007), Introduction: Principles of Fiscal Federalism, McGill-Queen’s University Press.”

[13] “Oates, W. (1999), “An essay on fiscal federalism”, Journal of Economic Literature, Vol. 37/3, pp. 1120–1149.”

[14] “https://economictimes.indiatimes.com/news/economy/finance/gst-regime-altered-contours-of-fiscal-federalism-in-india-debroy/articleshow/104404821.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst”

[15]“<The Constitution of India>, § <Section 245>, Acts of Parliament, <1950>.”

[16]“<The Constitution of India>, § <Section 254>, Acts of Parliament, <1950>.”

[17] “(2022) 2 SCC 603”

[18] “ <The Constitution of India>, § <Section 279>, Acts of Parliament, <1950>.”

[19] “2022 SCC OnLine SC 657”