A cess on GST to compensate states is bizarre

Ever since Goods and Services Tax (GST) was proposed by the Centre, state governments have been agreeable to move over to the new regime provided the Centre agrees to compensate them for the losses suffered due to relinquishing their right to tax goods and some services. The Centre has generally been positive to such requests and has even gone to the extent of drafting a Goods and Services Tax (Compensation to States for Loss of Revenue) Bill, 2016.

It now appears that the Centre has found an easy way to pay out this compensation — levy a cess on the GST tax itself. It was initially thought that the cess would be levied only on luxury and demerit goods, but it is likely to be added on to the neutral rates of GST— a strategy that is obvious because the population of GST taxpayers would be much larger than those in the demerit and luxury brackets. In effect, this would result in a unique situation wherein a taxpayer in Karnataka would compensate his own state government!

The Centre derives its powers to levy a cess from Article 270 of the Constitution which states that all taxes and duties referred to in the Union List — except the duties and taxes referred to in Articles 268 and 269, respectively, surcharge on taxes and duties referred to in Article 271 and any cess levied for specific purposes under any law made by Parliament — shall be levied and collected by the Government of India and shall be distributed between the Union and the States.

Such percentage, as may be prescribed, of the net proceeds of any such tax or duty in any financial year shall not form part of the Consolidated Fund of India. It shall, instead, be assigned to the states within which that tax or duty is leviable in that year, and shall be distributed among those states in a manner and from a time as may be prescribed.

India has a long history of levying cesses for an eclectic variety of purposes. Initially, an education cess was levied to improve education standards. Even as it was in existence, we were introduced to a Secondary Education Cess, again with the stated purpose of funding secondary education. More recently, we have been witness to a Swachh Bharat Cess and a Krishi Kalyan Cess. We have had a Clean Energy Cess on coal production from 2010. Finally, we have the Clean Environment Cess which is a sort of a carbon tax.

Therefore, it is clear that cesses are levied only for specific purposes. By logical extension, cesses should be for a limited period of time and should form a tax in themselves. Unfortunately, this has not happened in India-hardly a few cesses have been withdrawn and some cesses like Krishi Kalyan Cess have become taxes by themselves. For instance, the Clean Energy Cess has been increased on a couple of occasions more with an intention to garner revenue than to act as an incentive to produce clean energy. For academic purposes, let us call the proposed cess on GST as “States’ Compensation Cess (SCC)”.

Specific commitment
For multiple reasons, levying SCC is a bad idea. The most obvious question that arises is why should the taxpayer subsidise an obligation that the central government has entered into with the state governments? Apart from taxes, the central government has a number of other avenues to raise revenue which they have never implemented properly. For instance, they can divest a small percentage of their holdings in Maharatna public sector undertakings and raise much more than what a cess would garner.

The Centre has made it clear that they would compensate the states for all their losses for five years which would lead one to conclude that the SCC would not be collected after five years. One is unsure if this would happen with the SCC. No cess that has been levied till date has had a sunset clause which specifies when it would be withdrawn. In case a cess is collected, there should be a specific commitment that it would lapse automatically after five years.

The very thought of imposing a cess even before the law has been implemented portends to a very dangerous possibility — that the government resorts to this whenever GST revenues are strained. As on date, no one is aware as to how much of losses state governments would suffer because of transitioning to GST. In fact, one is not sure if there will be losses in the first place since some goods, such as liquor and some petroleum products are not subject to GST.

The ideal way to compensate state governments for possible losses of revenue would be to earmark and park a portion of CGST revenues into a States Compensation Fund. During the first few years after GST makes its start, it would be possible for the government to get a realistic estimate of the losses that state governments would incur due to transitioning to GST. It is at this time that the government should think of replenishing the Fund through means other than cesses and surcharges in case the earmarked funds are insufficient to meet the amount of compensation.

The forced postponement of GST implementation should be considered as a blessing in disguise as many loose ends in the Model GST law can be tied up. It is time the government takes a good hard look at the tendency to slap a cess as per its whims and fancy on unsuspecting taxpayers.

As there is no transparency on how the cess has been utilised, whether primary/secondary education has improved, Bharat has become Swachh or the agriculture has developed is reduced to a guess work. If this trend continues, taxpayers may soon be paying a Demonetisation Cess — a cess to compensate the state governments for the economic impact of demonetisation.

(The writer is a Bengaluru-based tax expert)