Critics of the current GST setup have pointed out that the original aim of having a single rate for all goods and services was done away with. A multiple slab structure, they added, had introduced needless complexity into the system. It had introduced absurdities, where luxury items like gold and jewellery were taxed at the lowest rate, while essentials like sanitary pads were taxed much higher (though, subsequently, the government exempted sanitary pads altogether from GST).

The larger question is, how has GST performed, and has it been fair and equitable to states? The latest headline numbers paint a rosy picture. This April, GST revenues clocked in at ₹2.1 trillion, the highest ever for a month. GST revenues stood at 6.62% of the gross domestic product (GDP) for the fourth quarter of 2023-24, much higher than the corresponding quarters for the preceding two financial years (Chart 1).

But a deconstruction of GST numbers over seven years, especially from the perspective of states, reveals expectations belied and friction points aplenty.

The numbers above cover both so-called 'central' and 'state' GST collections, which are both imposed on goods in equal proportion (usually, at 9% each). States are entitled to all state GST revenues earned from goods bought and sold within a state. If a good is sold across state borders, the GST revenue (called integrated GST) is shared equally between the Centre and the state where the consumer is located. Further, the revenue earned by the Centre by way of central GST, and its share of IGST, is shared with states in the same way as corporation or income tax is—as recommended by the Finance Commission. Currently, that means that around 41% of central GST revenues are shared with states under a predetermined formula.

This April, GST revenues clocked in at ₹2.1 trillion, the highest ever for a month

The GST system made fundamental changes to the financial independence of states. Until the introduction of GST, states and even municipalities had the power to impose a range of taxes on goods entering or leaving their jurisdiction. For instance, octroi imposed on goods entering Mumbai was a major source of revenue for the country's richest municipality, the Brihanmumbai Municipal Corporation (BMC). When GST was introduced and octroi killed, the BMC had to be compensated to the tune of thousands of crores every year for octroi.

Such compensation was part of a broader framework promised to states, in exchange for giving up control over various taxes such as octroi, luxury tax and state value-added tax, among others. For a period of five years, states were promised compensation for the revenue losses they might suffer from the introduction of GST. This compensation was funded through a special cess imposed on certain goods. However, the compensation ended in June 2022 (though the cess will continue to be imposed to pay off loans that the Union government took to pay compensation).

With the ending of the cess, states will have to make ends meet on their own. To what extent have they been successful?

The Grand Bargain

Underlying the explicit deal between the Centre and states, which promised states compensation for revenue lost from state taxes subsumed into GST, was a deeper if implicit, bargain. This was the creation of a common market for goods and services by the introduction of a uniform tax system applicable across states, at a uniform set of rates. The claim was that by creating such a common market, businesses would find it easier to transact and sell across the country. This would lead to an increase in economic activity, greater tax revenues, and ultimately more money for state coffers.

Chart 2 shows how that bargain has actually worked for state-level taxes included in GST—that is, those taxes that states gave up control over on implementing GST. The state GST revenues as a share of state GDP have actually fallen, from 3% in the pre-GST period to 2.7% in the post-GST years. But this overall number conceals wide variations across states.

The standard narrative is that GST is a consumption-based tax. Hence, states that are richer, and in turn have a higher proportion of richer consumers, stand to benefit from a GST system. Further, consumers in richer states will spend a greater share of their wallets on luxury goods taxed at the highest GST slabs. Thus, richer states should do well from the shift to a GST system.

'Levelling Up' Effect

There is certainly evidence for this. India's most industrialised states, such as Maharashtra, Goa or Gujarat, have seen their state GST revenues rise as a share of state GDP. But other states that are also relatively more affluent have actually seen the share of state GST revenues in state GDP decline—Karnataka from 3.4% to 2.8%, Tamil Nadu from 2.5% to 2.3% and Andhra Pradesh from 3.2% to 2.3%. Interestingly, at the other end of the scale, relatively poorer states have seen their state GST revenues rise as a share of state GDP—Bihar from 3.3% to 4.7%, Uttar Pradesh from 2.9% to 3.2% and Jharkhand from 3.1% to 3.9%.

One possible explanation is data found in a Crisil report on extrapolating consumption trends from per capita GST collections in each state. While the report found a sharp correlation between GST revenues and per capita income in each state (in line with expectations), it also found that growth in GST collections was similar across states, irrespective of income.

For example, the average annual growth in GST collections in Telangana (annual per capita income of ₹3.44 lakh) between 2019-20 and 2023-24 was 14.7%. This was similar to the average annual growth in GST revenues in Bihar (15.6%), a state whose annual per capita income was just ₹59,639, for the same period. "One way to think about such a trend is that it likely indicates a similar pace of adoption of GST across states, irrespective of their income levels," says the report.

Seen another way, GST has improved the efficiency of tax collection in poorer and richer states alike. Further, states that were previously less efficient in collecting taxes controlled by them now have greater funds accruing in state coffers simply because taxpayers in that state, and elsewhere, are subject to the same tax collection system as a taxpayer in Maharashtra. There is thus a 'levelling up' effect, where tax administration achieves similar levels of efficiency across all states.

But if this is the explanation, it also implies this is a one-time effect. Improvements in running the GST system cannot last forever, and ultimately, it will be the level of affluence of the state that will affect the future path of GST revenues. States that already had more efficient state-level tax collection machinery in the pre-GST dispensation, such as Tamil Nadu and Andhra Pradesh, would have seen less of a bump from the benefits of an improved GST collection system

The Bigger Picture

The broader picture of a decline in revenues post-GST holds when we look at overall GST collections, including the Centre's share. A 2023 paper by Sacchidananda Mukherjee of the National Institute for Public Finance and Policy looks at the national level picture in GST collections, compared with tax collections in the pre-GST era.

In the four years up to 2016-17, revenues from relevant taxes as a share of (nominal) GDP averaged 6.13% of the GDP. By comparison, the average intake in the post-GST era (2018-19 to 2022-23, including covid years) was 6.16% of GDP. However, this includes GST compensation paid to states (and raised from a separate cess imposed on taxpayers). Excluding this, as Mukherjee points out, the GST intake falls to 5.68%—well below the rate of pre-GST taxes in GDP.

What about the total revenues that the states earned in the post-GST era, including the amounts due to them from central GST? Before GST, such revenues amounted to 4.15% of GDP. After GST, and excluding GST compensation, that amount falls to 3.63% of GDP. For the Union government as well, the share of GST revenues due to it (after paying out dues to states), compared with taxes it had to forego; fell from 1.98% of GDP to 1.5% of GDP. On the positive side, the so-called 'tax buoyancy'—the extent to which GST revenues increase compared to the rise in GDP—rose in the post-GST era.

State Complaints

Little wonder then that many states, including more affluent ones that were supposed to benefit from GST, have complained about losing out. Last week, in the latest GST council meeting, the forum where the Centre and states sit together to set GST tax rates on various goods, Kerala said states should receive a greater share of GST revenues. Writing in The Hindustan Times, Mint's sister publication, academics K.J. Joseph and Kiran Kumar Kakarlapudi have argued for something similar and have also called for incorporating the cess into the main GST rate structure.

Of the countries that have GST, 80%, including Singapore, New Zealand, the UAE and Japan, have opted for a single tax rate and were successful in increasing compliance and minimising tax disputes

Elsewhere, analysts have, for long called for a single GST rate on all products, which would simplify the administration of GST drastically. "Of the countries that have GST, 80%, including Singapore, New Zealand, the United Arab Emirates, and Japan, have opted for a single tax rate and were successful in increasing compliance and minimising tax disputes," pointed out Joseph and Kakarlapudi.

Reforms to GST can't be seen in isolation. A major, and legitimate, complaint of states has been that revenues raised from cesses on various products, or even income (not necessarily just under GST), are not shared with them by the Centre. And so, it has a natural incentive to raise more tax revenues this way. The new Finance Commission could seriously explore adding cesses to the pool of taxes shared with states. In return, states and the Centre could agree on a lower, single rate of GST, which could benefit businesses and consumers across the country.