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States that have huge mineral and petroleum reserves, but are economically backward may face significant loss of tax revenues on implementation of goods and services tax (GST), according to economists and experts in public finance. Introduction of GST would lead to the abolition of central sales tax (CST), which is collected by state governments on inter-state sales of goods. The CST rate was reduced from 4% to 2% at the time of introducing value added tax (VAT) in 2005.

Some states may have a revenue shortfall initially, though under GST they are to be given the right to tax services for the first time, said Asim Dasgupta, chairman of the empowered committee of state finance ministers which is working on the finer and final aspects of GST, which could create an unified market within the country for the first time.

Consumption of services is normally low in economically backward states, said R. Kavita Rao, a professor at National Institute of Public Finance and Policy, Delhi. “Their income from CST too may not be significant,” added Rao. “But if a state is rich in mineral reserves, the deficit could be significant.”

To compensate such states, the Central government would provide financial assistance like it did at the time of introducing VAT, said Dasgupta. States have been pressuring the Central government to compensate them for up to five years.

Also, though GST rates would be uniform across the country, there would be provision under which a state could “through discussion with others” change the tax rate to tide over financial crisis, said Dasgupta.

“I think, states could be allowed to increase tax rates without disturbing the basic two-rate structure of GST,” said Rao. “However, states might not be allowed to reduce taxes… If a state decides to raise tax, it would be taking a revenue-risk. It should not affect any other states.”

GST, however, may not lead to a uniform two-rate structure across the country in the long run, said Rao. After the initial years through which the centre will compensate states for revenue deficits, states may not agree to a common structure “unless bound by the constitution or some alternative mechanism”. “In my view, there is no reason for states to agree to such a bind, but if they do, it’s the end of the debate,” she said. “What GST effectively does is include services in the VAT net.”

Dasgupta, however, said in an interview that GST is the most comprehensive step ever taken in India towards indirect tax reforms.


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May 2024