JANUARY 29, 2014

By TIOL Edit Team

RESERVE Bank of India's (RBI's) study 'State Finances-A Study of Budgets of 2013-14' has shed a new light on the progress achieved by the States in fiscal consolidation.

The Study, which was released last week, shows that 22 out of 28 States have budgeted revenue surplus in 2013-14.The States' fiscal consolidation is in line with the roadmap laid down by the 13th Finance Commission). During 2013-14, the revenue surplus-GDP ratio is budgeted to increase to 0.4% from 0.2 % in previous year, contributing to a reduction in the GFD-GDP ratio to 2.1% from 2.3 % in 2012-13.

This should add some life into the Centre-State negotiations on goods and service tax (GST) that have lost all steam against the backdrop of general elections. The Study's implied message is that most of the States are on strong fiscal platform to take the GST plunge.

As concluded by the Study, "Sub-national governments seem to be ahead of the Centre in fiscal consolidation, with most state governments recording surpluses in their revenue accounts and keeping their GFD (gross fiscal deficit) targets within those stipulated by their FRBM Acts. However, it may not be fiscally prudent to build large revenue surpluses at the cost of development expenditures. If revenue surpluses are effectively used in building capital assets, this could contribute to higher growth, given the large multipliers for capital outlay, particularly at the state level."

This rosy picture about States' finances should, however, be taken with a pinch of salt as several States have their own off-budget liabilities such as unpaid power subsidies to power distribution companies (discoms) just as the Centre has its off-budget liabilities.

Notwithstanding this caveat, this RBI's annual study should prove handy to the 14th Finance Commission in not only preparing fiscal road-map for both the Centre and the States but also in recommending devolution of resources to the States.

FC has so far interacted with representatives including Chief Ministers of 18 States.

Several States have demanded hefty increase in their share in net proceeds of shareable central taxes to 50% from 32 per cent as at present, which is based on the recommendations of previous Finance Commission.

It would be magical if the Finance Commission could formulate a workable mechanism that links any enhancement in the States' share of shareable central taxes with the implementation of tax reforms notably long-pending GST.

Such a mechanism is desired as the previous Finance Commission's recommendation for "Grand Bargain" between the Centre and the States on introduction of GST has not materialized. States also did not feel enthused by FC recommendation to sanction Rs. 50,000-crore grant to the States for implementing grand bargain. This grant is to be used to meet the compensation claims of State Governments for revenue losses on account of implementation of GST between 2010-11 and 2014-15, consistent with the Grand Bargain.

FC might well have to enhance or perhaps double this grant to facilitate an agreement between the Centre and the States on GST.

RBI Study has also appropriately expounded the rationale and benefits of introducing goods and service tax (GST), apart from discussing transfer of plan and non-plan funds from the Centre to States.

Giving an update on progress achieved in striving for an accord on GST, the Study notes: "An early resolution of differences between the centre and the states and among the states themselves will facilitate removing the legislative hurdles for the introduction of GST, with attendant benefits to tax revenue and growth in the medium term."

Some of the important issues which need to be resolved include (i) revenue neutral rate for GST; (ii) compensation from the central government for short-term losses, if any, arising from the shift to the proposed GST tax regime; (iii) rules relating to 'place of supply' in order to bring about clarity as to which state will have jurisdiction over transactions in case of services that are complex; (iv) raising the exemption threshold for the benefit of small businesses and; (v) issues relating to the introduction of an integrated GST (I-GST).

As the Finance Commission enjoys the confidence of both the Centre and the States, it should strive to resolve these issues though this job is not explicitly specified in its terms of reference (TOR).

TOR requires Finance Commission to factor in its award/recommendations the impact of proposed GST on the finances of Centre and States and the mechanism for compensation in case of any revenue loss.

RBI study shows that the states' own tax revenue-GDP ratio has grown from an average of 5.8 per cent during the high growth phase, i.e., 2004-08 to 6.6 per cent in 2012-13 (revised estimates).

As put by it, "While there could be some revenue loss to the states in the short-term due to reduced manoeuvrability in fixing tax rates, improvement in tax compliance, facilitated by the IT infrastructure to be used for GST implementation, is expected to increase tax buoyancy in the medium term."

The adoption of GST will streamline the country's entire indirect tax system by reducing inter-state differentials in tax rates, subsuming a large number of taxes into an aggregate levy, which, once paid, can be claimed as credit against subsequent tax payments anywhere in the country. GST is also expected to induce many micro and small producers to enroll themselves into the tax system as GST is the key to acquiring competitive edge in the economy.