Ind-Ra: GST Credit Positive for States in Medium to Long Term

India Ratings and Research (Ind-Ra) says the implementation of goods and services tax (GST) will have a positive impact on state governments' finances in the medium to long term. Even in the short term, the impact on aggregate state finances will be positive but Ind-Ra's calculation shows that the picture varies across states.

Nine state-level taxes included in GST are: state value added tax, central sales tax, purchase tax, luxury tax, entry tax (all forms), entertainment tax (except those levied by local bodies), taxes on advertisements, taxes on lotteries, betting and gambling and state cesses and surcharges insofar as they relate to the supply of goods or services. However, taxes on i) income, ii) property and capital transactions, iii) petroleum products, iv) state excise and v) electricity duty are not part of GST and states would continue to levy and collect these in the same manner as earlier.

At an aggregate level, the state taxes that are subsumed in GST accounted for 55% of states' own tax revenue and grew at 14.0% during FY12-FY17. This is exactly the rate at which if state taxes that are subsumed in GST grow in FY18 over FY16, then centre will not be required to compensate states for any revenue loss. However, there are wide variations across states, with subsumed GST taxes growing at just 8.47% for Punjab during FY12-FY17 but 39.70% for Telangana.

Ind-Ra's calculation shows that GST revenues of all states combined will grow at a CAGR of 16.6% in FY18 over FY16. However, since the picture at the individual state level differs, eight states namely Andhra Pradesh, Chhattisgarh, Gujarat, Himachal Pradesh, Madhya Pradesh, Odisha, Punjab and Tamil Nadu would need compensation from the central government for any revenue loss under baseline scenario. This would cost INR56 billion to the central government in FY18.

As post introduction of GST, input tax credit is available on both goods and services, Ind-Ra's calculation shows that the growth of GST component of states' own tax revenue for all states in such a case would drop to 15.5% in FY18 (base line scenario 16.6%) and three more states namely, Goa, Jammu and Kashmir and Jharkhand would require compensation from the central government. The total compensation amount therefore would increase to INR95 billion in FY18 (baseline scenario: INR56 billion). This is based on the assumption that in the final production of goods and services, service tax accounts for 10%.

Like the state VAT which was rolled out from April 2005 to January 2008, implementation of GST will also bring in some efficiency gains. If we combine the 5% efficiency gain with 10% input tax credit on services tax, then only five states namely Chhattisgarh, Gujarat, Odisha, Punjab and Tamil Nadu would need compensation from the central government and the total compensation amount would drop to INR37 billion in FY18.

To be able to absorb the positive impact of GST on state finances, Ind-Ra believes states will have to keep a constant vigil on the buoyancy of taxes that are outside the purview of GST as also their own non-tax revenues.

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