Elections in a federal system and the GST

An electoral battle in a constituent state of a federal system is supposed to be fought on policies and issues falling within the functional domain of states. Members of the legislative assembly (MLAs) are expected to seek re-election on their record in terms of what they promised to deliver when they got voted in. All MLAs have a local area fund entirely under their control. They can speak of the uses to which they put their MLA fund. They can contrast that with constituencies which made the mistake of electing MLAs from other parties.

If a member is on a weak wicket in terms of his personal record, he may then take recourse to asking the state-level leadership of his party to come to his aid. The state leader can trumpet the achievements of the government at state level, speaking, say, of the reduction of maternal mortality achieved, and telling women in the audience that they have a higher probability of surviving childbirth if they vote back the party to power, thus shifting attention from the individual MLA to his party affiliation, and urging them to vote him back so as to get the majority they need to form the next government and continue the downward path of maternal mortality.

The party in power at the Centre should ordinarily be of no relevance. But this is not the way the two December state elections, or any of the prior state elections, were fought. Political parties have become brands, like Lux versus Lifebuoy. That, in turn, has turned every state election into national entertainment, deflecting attention from issues that critically matter for people everywhere in the country which can only find redressal at state or local level—like agricultural distress, air and water pollution, or road congestion, safety in public places, or public health scourges like dengue and chikungunya and encephalitis.

Yes, agriculture (a state subject) did loom large as an issue in the Gujarat elections, but even that was fought on a brand basis. Both brands claimed they had the interests of farmers at heart. Even though many policy levers, even for a state subject like agriculture, are controlled at the Centre, this shift in attention to the Centre benefited no one. The elections just became a way by which farmers in south Gujarat could send a distress signal by shifting to another brand. They needed candidates who could tell them the specifics of what could be done by the state to address both their immediate as well as their long-term concerns. The only state-level issues not fought on a brand basis were the Patidar agitation (sectarian), and the Dalit agitation (not sectarian albeit caste-based, centred around non-delivery on past promises).

More theatres of warfare between the two major political parties are in the offing in 2018. Eight states are up for elections, each threatening to become a referendum on policies at the Centre. We need to think seriously about synchronizing state and national elections, so that voter choices at state level are made without knowing which party will form the government at the Centre. One would have thought that political parties, burdened as they are with the problem of finding funding, would favour synchronized elections. Democracy is one of our strengths, and in a country as large as India, there is indeed no other basis on which it can be run. However, we need a rethink on how to restructure the electoral system so as to give the voter a voice, rather than, as presently, take it away.

The Chinese success in delivering to its people without electoral democracy has generated a serious empirical investigation of whether democracy facilitates growth, by a team headed by Daron Acemoglu, a prominent economist. The paper, ‘Democracy does cause growth’, currently in circulation as a white paper and to be published this year, concludes that democracy is indeed growth-promoting, from a cross-country study covering 1960-2010. The paper is really an investigation of transitions from non-democracy to democracy, and so in a sense does not quite capture countries like India which had already made that transition by 1960 (and fortunately did not transition out), but the channels through which democracy ramps up growth are instructive.

These include state and local issues like quality and reach of schooling (implicitly coupled to child nutrition programmes), and public goods benefiting all, such as sanitation and transportation networks. Others, like structural reform leading to greater efficiency in the system, clearly need doing at the national level. Some, like agriculture, are state subjects, but can be driven by national initiatives.

A national-level reform which was justified as an issue in the Gujarat elections, as indeed it will be everywhere because it reaches so deeply into the structuring of the Indian economic machine, is the goods and services tax (GST). We are told by election pundits that the traders in Surat decided to vote for the Bharatiya Janata Party in Gujarat despite their initial distress with the structuring of the GST because the government at the Centre heard them and relaxed the voucher-based filing frequency for small traders. But now that the average monthly revenue collection over the July-September quarter of Rs0.93 trillion has fallen to Rs0.83 trillion in October, and further to Rs0.81 trillion in November, a rethink is under way on some of the other design changes that have been made in recent months to the GST, with the prospect of partial or full rollback. The big revenue drop happened in October.

The revenue decline is indeed a serious matter, but the possible causes need to be disentangled so as to advance the GST story rather than set it back further. With the exception of those on the composition scheme, the revenue due for any month is currently payable by the 20th of the succeeding month through form GSTR 3B, an unverified interim summary of tax collected net of taxes paid. This is then adjusted to the detailed voucher-specific information called for in forms GSTR 1 (outward supplies) and GSTR 2 (inward supplies), whose deadlines come later.

The information in GSTR 1 is supposed to “populate” the voucher-based claims in GSTR 2 by the buyer, and if a claim is not verified in that way, the input tax credit (ITC) claim of the buyer is denied. But since the deadlines for these kept getting extended on account of non-compliance, there has been constant revision of revenue collections for earlier months. A recent extension up to 10 January 2018 for the period July to October means that even the July figure remains provisional.

The shift in the filing frequency, already alluded to in connection with Surat traders in the Gujarat elections, from monthly to quarterly for small traders was made in early October. The shift in the filing frequency already alluded to from monthly to quarterly for small traders was made in early October. That may have been what revised September collections up to the highest monthly record so far—Rs0.95 trillion, on account of denied ITC claims made in the interim submission, and this will most likely happen in the last month of every forthcoming quarter.

In mid-November, deadlines for filing of GSTR 1 were further extended, but deadlines for GSTR 2 were not prescribed, for the remainder of the current financial year. In effect, voucher matching as a prerequisite for honouring input credit claims stood temporarily suspended.

This move away from voucher matching is thought to have been what caused the revenue decline in October, since it became effective in mid-November before the submission deadline of 20 November for GSTR 3B for October. According to reports, this might well lead to GSTR 2 being brought back, with thereby a return to universal voucher matching.

My opinion has consistently been that voucher matching is needed only for transactions involving integrated GST (IGST), because cross-state sales are the most promising avenue for fraud (and were, even in the earlier state value-added tax system). A full rollback to universal voucher matching will generate the widespread frustrations over denied (although perfectly valid) input tax credit claims, and with that, a return to the hostility towards GST which had abated somewhat since November.

The other change effective mid-November was a major round of rate reductions, leaving very few products at the topmost rate of 28%. The further fall in revenue by Rs0.02 trillion in November relative to October may well have resulted from those, but because it happened mid-month, there was no time for the demand response to the rate cut to show up. The demand impact could well show up as early as December.

Also on the anvil are e-way bills as a way to combat fraud, of the inter-state variety. There is also every prospect that the reverse charge mechanism (RCM) will be brought back, whereby buyers forward tax payable on inward supplies from outside the formal GST net (composition or unregistered), and lodge a simultaneous credit claim on it. The RCM will be resented for the additional compliance burden, but will probably not be harmful in terms of economic activity. The e-way bill, on the other hand, could seriously reverse a major efficiency benefit reaped under the GST, which is free movement of goods without checks at state borders.

What the council will do in response to the October-November revenue decline will have an impact on the forthcoming state elections. The need to combat fraud is real, but the best way to do this while still retaining the essential attribute of value-added taxation—upfront honouring of input tax claims—will be to confine voucher matching to IGST transactions. All other tax credit claims can be honoured as self-reported, with auditing checks on a sample basis. It is inter-state flows, encompassing exports out of the country, where the opportunities for fraud are greatest, which need to be curbed through a within-system cross-check of IGST payments. As for the rate reductions, any reversal would set back the long-term goal of the GST, which is to have a low rate of levy on a wide transactions base.



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