Does GST in India hurt producing regions? A new estimate of the tax base under GST of select states

Abstract

GST as introduced in India being a destination based tax, does not encourage regions to vigorously promote manufacturing and tradable services industries. Being in the midst of its economic transformation, and given the subnational character of most states (regions), it is important that the states engage in locational tournaments to attract investments, not through tax concessions, but through the provision of infrastructure services, governance, and other intangible services. A new consumption based approach that adjusts the detailed consumer expenditure figures of the National Sample Surveys at the state level is developed. This is shown to be robust and is used to estimate the RNR (Revenue Neutral Rate of Taxes) at the State level. This reveals that there are stark differences between the rates for the producing states and the consumption oriented states amounting to as much as 10% of GDP. These differences cannot be bridged by the proposed compensation scheme. As the impact of GST goes on to the next stage of determining the locational choices of new investments, the lack of fiscal incentives for states to attract and nurture investments, unless corrected would have deleterious effects on the investment process. As much as 50% of the Centre’s collection of GST may have to be distributed based on economic activity centered around 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 contrast with China is remarkable, China’s GST is only partial covering only manufacturing and associated labour services, allowing states to tax and retain many services irrespective of the location of the consumer of the service. More importantly as much as 25% of the central collections on account of GST( in manufacturing) go to the provinces based on their public goods production.