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14th September 2023 (10 Topics)

The new sharing

Context:

The Sixteenth Finance commission constituted recently, has to take a stand and must re-examine revenue allocation among states in light of post-GST changes.

The Transformation of India's Taxation System

  • Introduction to GST: The 122nd Constitutional Amendment of 2016 brought about a significant change in India's fiscal landscape, introducing the Goods and Services Tax (GST) regime in 2017.
  • Shifting Dynamics of federalism: GST shifted India from a production-based taxation system to a consumption-based one, reshaping the dynamics of federalism by allowing both the Union and states to collect indirect taxes.
  • Increasing tax burden on states: The destination principle for cross-border trade ensured that consuming states benefited, in contrast to the earlier system where rich manufacturing states exported tax burdens to consuming states.

Challenges and the Need for Reforms

  • Discrepancies in Fiscal Transfer System: Despite the shift to a consumption-based tax system, India's fiscal transfer system remains based on the principles of the previous origin-based tax era, leading to disconnects between operational tax regimes and sharing criteria.
  • Present re-examination: The upcoming 16th Finance Commission should be tasked with re-examining tax-sharing principles in light of the new fiscal federalism landscape.
  • Issue of IGST: Reforms should start with redefining the divisible pool, including unsettled IGST with input tax credit, and addressing cash flow issues for state governments.

Redesigning Tax Sharing and Fiscal Monitoring

  • Addressing Horizontal Distribution: Criteria for the distribution of the divisible pool among states, particularly for equalizing grants, need to be reimagined to align with the consumption-based tax system.
  • Compensation grants:The fiscal year after the GST compensation grants, which extend to March 31, 2026, will be the base year for the 16th Finance Commission's award from 2027 to 2032.
  • Approach based reforms: The need, viability, and desirability of the compensation scheme should be reviewed, considering the revenue performance of GST during the past six years.
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