GST and the Discrimination Against Production Oriented States

Goods and Services Tax as introduced in India, being a destination oriented tax, does not encourage regions to promote manufacturing and tradable services industries. The country is at an early stage of its economic transition, and the states have a subnational character. It is important that the states engage in locational tournaments to attract investments by providing infrastructure services, governance, and other public services. We develop a new consumption-based approach that adjusts the detailed consumer expenditure figures of the National Sample Surveys at the state level to estimate the Revenue Neutral Rates at the state level. There are stark differences between the rates for the producing states and the consumption-oriented states amounting to as much as 20% of GDP. The divergence is higher than those arrived at by the Government before the introduction of GST. The proposed compensation scheme that protects revenue at 14% growth for 5 years would be unfair to the producing states once the 5 years are over. As GST impacts the locational choices of new investments, the lack of fiscal incentives for states to attract and nurture investments, unless corrected, would have deleterious effects. A significant share of the Centre’s collection of GST may have to be distributed based on manufacturing and tradable services production, if the country is not to lose the steam of high and growing investments to take it through its economic transformation. The institutional mechanism for GST, viz., the GST Council in its present form would make it difficult to quickly cut or raise tax rates including across the board changes that are necessary for macroeconomic management.