On May 13, the government told us that between August and December this year, the covid vaccine availability/production will be ramped to around 216 crore doses. Tweets were published by several government handles. (You can take a look here and here).
Many media reports were also published regarding the same. As the Mumbai edition of The Times of India reported on May 14: “Setting out its roadmap to vaccinate the around 95 crore 18-plus population, the Centre said on Thursday India should be able to access nearly 217 crore doses between August and December.”
The following table shows how the 216-crore number was arrived at.
Source: Ministry of Health and Family Welfare. In case you are unable to see the table, click here.
Several ministers reiterated this message. Prakash Javadekar, who holds multiple portfolios in the government, said: “India will get 216 crore new vaccines by December. India will be able to vaccinate more than 108 crore people with the help of these vaccines.” The health minister Dr Harsh Vardhan also made a similar statement.
The underlying message here was that the vaccine shortage, if any, would not be a problem in the months to come. Over the next few days, WhatsApp and other social media kept buzzing with this message. The above table was shared over and over again. The Be Positive crowd had a field day. So far so good.
The trouble is that the numbers in the table are just that, numbers. Allow me to explain.
75 crore doses of the Covishield vaccine are expected to become available between August and December, a period of five months. This implies a production capacity of 15 crore doses per month on an average.
In a submission to the Supreme Court on May 9, the government had said that the manufacturing capacity of the Serum Institute, the company which manufactures Covishield, is expected to go up from 5 crore doses per month to 6.5 crore doses by July 2021. Increasing production capacity from 6.5 crore doses per month to 15 crore doses per month is going to be some task.
Of course, the government always has the option of importing the Astra-Zeneca vaccine doses (which is locally manufactured as Covishield). But even if the government decides to import, the difference between the local production capacity and the projection of 15 crore doses per month on an average, is huge. Further, any imports will come at the expense of denting the atma nirbharta narrative.
When it comes to Covaxin, the estimated production between August and December has been assumed to be at 55 crore doses. This implies a production of 11 crore doses per month on an average.
The central government told the Supreme Court on May 9 that the manufacturing capacity of Bharat Biotech, the company which currently manufactures Covaxin, is expected to go up from 90 lakh doses per month to 2 crore doses per month, and further increase to 5.5 crore doses per month by July 2021. So, 5.5 crore doses a month is half of the 11 crore doses per month that is required as per the government’s calculation.
Of course, it needs to be remembered that the intellectual property for Covaxin is shared between Bharat Biotech and the Indian Council of Medical Research. Hence, Covaxin will also be manufactured by three public sector manufacturing facilities. These are Indian Immunologicals, Hyderabad, Haffkine Biopharmaceuticals, Mumbai, and Bharat Immunologicals and Biologicals, Bulandshar.
Based on this, the government told the Supreme Court: “This is projected to enhance Covaxin‟s current manufacturing of 1 crore doses/month to nearly 10 crore doses/month in the next 8-10 months.”
So, Covaxin’s production is expected to touch 10 crore doses per month only in 2022. At least, that’s what the central government told the Supreme Court. Nevertheless, that did not stop them from telling you and I, that 11 crore doses per month of Covaxin will be produced on an average between August and December. Given this, the vaccine production projections made by the government, don’t pass the basic smell test.
And we aren’t done with this yet. A close look at the above table tells us that it also includes doses from vaccines which haven’t been cleared for production. In fact, this was precisely the point made by the two amici appointed by the Supreme Court ( Jaideep Gupta and Ms Meenakshi Arora) in the Suo Moto writ petition that the Court is currently hearing.
As Wikipedia points out: “An amicus curiae (literally, “friend of the court”; plural: amici curiae) is someone who is not a party to a case who assists a court by offering information, expertise, or insight that has a bearing on the issues in the case.”
As the Amici told the Supreme Court:
“The [central government] has claimed that it will be able to vaccinate a substantial number of persons (around 100 crore persons requiring 200 crore doses) by December 2021. However, no projections have been shared with this Court regarding how this target would be achieved. Based on reports, it appears that the [central government] has factored a number of vaccines that are currently in their development stages to reach its projected number of 200 crore doses. This approach would be misguided as the success and efficacy of vaccines that are currently in the stage of clinical trials is uncertain and cannot be guaranteed.”
The interesting thing is that the central government hasn’t presented any projections of vaccine availability to the Supreme Court and in an affidavit submitted to the Court on May 9, it said: “It is difficult to predict the projections for vaccines given that it depends on variable factors such as introduction of new foreign vaccines, capability of increased production by existing manufacturers, among others.”
Of course, the variable factors did not stop the government in confidently telling us that 216 crore vaccine doses would become available between August and December, later this year. Something, it didn’t have the confidence to tell the Supreme Court on May 9, it told the country on May 13, four days later, and has been saying it over and over again since then.
What this tells us is that the submissions to the Supreme Court are clearly not good WhatsApp material and hence, things can be said as the way they are.
Nevertheless, the Solicitor General, during the course of his oral submissions to the Supreme Court, did say: “He is in a position to address these concerns of this Court and that the UoI aims to vaccinate approximately 100 crore persons by the end of December 2021.”
Nonetheless, there is a huge difference between an aim, a plan, and a projection, as we have seen in the calculations earlier in this piece. Numbers are just numbers and can easily be tortured to arrive at what one wants to say. The table accompanying this piece is an excellent example of this phenomenon.
But then on WhatsApp who is bothered about the details and the nuance. So, the main aim of the government was to project a confident be positive narrative and it did just that.
To conclude, it is safe to say that there is one truth out there for the Supreme Court and another for the country at large.
Earlier in the day today, I published a detailed thread on the demand-supply scenario of the vaccines against covid, in India.
If you have read that thread, this piece is not for you. If you haven’t, do keep reading.
Up until today (April 30), vaccines against covid were only available for those aged 45 and above.
The number of people aged 45 and above in India is around 35.6 crore. This projection can be accessed from the Youth in India 2017 report. Of this, 12.4 crore individuals have taken only one dose of the vaccine and 2.6 crore have taken both the doses. (This number was as of the time of writing and keeps changing).
This basically means that 20.6 crore Indians (35.6 crore minus 12.4 crore, who have taken one dose, minus 2.6 crore, who have taken both the doses), aged 45 and above, are yet to take even a single dose of the vaccine.
In order to vaccinate them, the number of vaccines required will be 41.2 crore (20.6 crore multiplied by 2 doses each). Over and above this, 12.4 crore individuals who have taken just one dose, need to take a second dose as well.
Hence, the number of vaccines required, for those aged 45 and above stands at 53.6 crore (41.2 crore, who haven’t taken any dose, plus 12.4 crore, who have taken one dose).
From tomorrow (May 1), vaccination is open even for those aged 18 and above as well. As per the Youth in India report, the number of people in the age bracket 20-44, stands at around 55 crore. It doesn’t have a break up for the age bracket 18-44. So, it’s only fair to assume that the number of individuals in the age bracket 18-44, will be around 60 crore. In fact, that is the assumption I worked with in my Twitter thread.
One of the readers pointed out that economists Renuka Sane and Ajay Shah in a piece estimate that the number of individuals in the age group 18-44 stand at 62.2 crore. I will work with this number here. (I am trying to workout a ballpark estimate here and not write a research paper).
The number of vaccines required for those in the 18-44 bracket stands at 124.4 crore (62.2 crore multiplied by two doses). The overall number of vaccines required to vaccinate everyone aged 18 and above, is, 178 crore (124.4 crore plus 53.6 crore).
This is where things get interesting. In May, Serum Institute (Covishield) is expected to produce 7 crore vaccines. Bharat Biotech (Covaxin) is expected to produce 2 crore. That’s 9 crore vaccines, when 178 crore vaccines are required. If we take vaccine wastage into account we are looking at a number higher than 178 crore and closer to 190 crore vaccines.
Serum Institute’s capacity is expected to go up to 10 crore vaccines by June and Bharat Biotech’s capacity is expected to go up to 6 crore by July. By July we will have 16 crore vaccines being produced per month.
Of course, other vaccines like Sputnik and Pfizer will also come in, and thus the supply will increase and go up to more than 16 crore.
The point is that the supply of vaccines will continue to be a problem for the next few months. There are only two companies and there is only so much they can produce.
What does this tell us? It tells us that the authorities assumed that there will be no second wave and hence, had no plans to vaccinate a large section of the population quickly. The government has been caught napping at the wheels.
Also, even with the availability of 20 crore vaccines a month, it will take at least five to six months, for a significant portion of the population to be vaccinated, so that the population can achieve herd immunity.
One reader on Twitter told me that the capacity may also be used to fulfil commercial export commitments of the vaccine suppliers. I have no idea about whether that is the case. If that is the case, vaccination of a significant portion of the population will take even longer.
This easily explains why state governments are running out of stocks. The supply is very low in comparison to the demand. This is a problem that is not going to go away at least for the next two months. This is also explains, why even though vaccination for those over 18 is now allowed, there aren’t vaccines available to vaccinate them.
Of course, there will be a great fight for access to vaccines, not just between state governments, but also between state governments and the private sector. That is what the current vaccine strategy will lead to.
I have already heard stories of corporates throwing money to ensure that their employees are vaccinated and can get back to work quickly. For them, it is the cost of doing business, which can be easily passed on to their consumers. Of course, this evidence is anecdotal, but many corporates, especially those in the services business, have an incentive in doing so. If this plays out at a significant level, it will make vaccines even more inaccessible for the common man.
Basically, it’s a royal screwup, which cannot be corrected quickly. Give it another five to six months and hope for the best.
Meanwhile, don’t step out if you can, and if you do, stay doubled masked!
Note: Detailed analysis takes time. Like this piece took three weeks to write. Hence, please continue supporting this effort. Every rupee helps.
Chintan Patel and Vivek Kaul
The devil, as they say, is always in the detail.
Nevertheless, in an era of instant digital journalism, where you, dear reader, are constantly bombarded with information, the real story, or should we say stories, often get buried under numerous headlines, lazy journalism, government press releases and the false news that is the flavour of the day.
But if one is willing to do some basic number-crunching, like we are, some interesting details and narratives can emerge.
This is one such story of the central government taking both the states and the common man, for a ride and that too in broad day light. At the risk of stretching the metaphor a bit too far, the scene of the crime is the petrol pump and the motive, the dire state of the economy.
But to do this story full justice, we need to set up the background with some dry, academic points as well as digress into some adjacent details.
So, kindly bear with us. While sensational things might get you excited and help us get a few more clicks, but as we said at the beginning, the devil is in the detail.
And here’s presenting the detail.
What’s the point?
Over the years, the central government has been sharing less and less of the overall taxes that it collects, with the state governments. This is the main point we make in this piece.
The annual budget of the central government is presented in February ever year. The budget is analysed by the media in minute detail.
However, amidst all the analyses, one subject that is often ignored is the financial relationship between the central government and the state governments. After all, much of the services that the government provides are in fact delivered by local and state governments.
It is worth remembering that while the central government collects the bulk of the taxes in the country, it’s the states that the taxes ultimately come from. And given that, this money in one way or another needs to go back to the states.
But does it? The short answer is no. And there is a longer answer which explains the reasons, has some nuance and which forms the heart of this piece.
This piece is divided into three sections. The first section provides a background on how tax revenue is transferred from the central government to the state governments and the role of the Finance Commission.
The second section focuses on a special tax category – cess and surcharge, their increased prominence in recent times, and how that raises prices of petrol and diesel.
The third and final section examines the trend of total transfer of funds from the central government to the state governments.
This is an opportune time for such an analysis, since this year’s Union budget was accompanied by the unveiling of the 15th Finance Commission’s report for the period 2021-22 to 2025-26.
So, read on, to find out.
Who Gets How Much?
The Constitution stipulates how taxes are collected and split between the central government and the state governments. It empowers the central government as well as the state governments to raise revenues from different sources of taxation.
The central government gets to collect more taxes while the state governments end up with the bigger portion of the expenditure, leading to a mismatch. This mismatch of money that is earned through taxes and other routes and money that needs to be spent, is referred to as a “vertical imbalance”.
Take a look at Figure 1. In 2018-19, the Union Government raised 62.7 per cent of the aggregate resources raised by both the Union and states, whereas the states spent 62.4 per cent of the combined aggregate expenditure. While Figure 1 shares data for just one financial year, what’s true for 2018-19 has also been true for other financial years.
Figure 1: Vertical imbalance (2018-19)
Source: 15th Finance Commission Report.
To offset this imbalance, the Constitution provides mechanisms for intergovernmental transfers – the transfer of funds from the central government to the state governments. A key player of this setup is the Finance Commission.
The Finance Commission (FC) is an advisory body that is appointed by the President every five years and which evaluates the state of finances of the central as well as the state governments, and determines how taxes collected by the central government are to be distributed between the central government and the state governments, and among the state governments.
Over and above this, the FC also recommends grants to states based on revenue needs, grants for local governments and grants for specific purposes e.g. health sector grants etc. Thus, there are two broad channels of transfer of funds under the FC umbrella – i) devolution of taxes, and ii) grants.
At the heart of the idea of intergovernmental transfers and tax devolution is the concept of ‘divisible pool’. The divisible pool is the portion of the taxes (technically referred to as the gross tax revenue) collected by the central government, which is distributed between it and the state governments. What this means is that all the taxes collected by the central government aren’t shareable with the state governments.
Till the tenth FC which tabled its report in 1995, only union excise duties and personal income taxes made up the divisible pool. Under this arrangement, 85% of the personal income taxes and 40-45% of excise duties were shared with the state governments.
In 2000, the tenth FC recommended a constitutional amendment to expand the divisible pool to all central taxes. The central government accepted this recommendation and the 80th Amendment was passed making a certain portion of central government taxes shareable with the state governments, effective retrospectively from April 1, 1996.
Further, the portion of the divisible pool that is shared with the states is referred to as the devolution of taxes and is determined by the FC. Before the14th FC which came into effect from April 2015, 32% of the divisible pool was shared with the states.
The 14th FC increased the share of the state governments in the divisible pool to 42%. At the same time, the sector-specific grants were eliminated. This decision was primarily in response to grievances expressed by the state governments. State governments prefer funding through devolution since such transfers are unconditional.
Other transfers of money, whether they are through FC grants, or through channels outside the FC (like schemes from central government ministries) impose policy priorities set by the central government over the state governments, compromising the latter’s fiscal flexibility or the ability to spend money as the state government deems fit.
To give an example, a FC health-sector grant can only be used for health spending by the states, or funds transferred to the states under Pradhan Mantri Gram Sadak Yojana can only be used to make roads.
When state governments have more flexibility in allocating funds for various initiatives, they can craft policy that is more responsive to the needs on the ground than having to blindly follow policy that is framed in New Delhi.
The 14th FC recognised this and increased the state share of the divisible pool from 32% to 42%. The intent behind this increase was not to increase the amount of transfers but rather change the composition of the transfers – from diverting conditional funds to diverting unconditional funds, to state governments.
The 15th FC tabled in 2021 lowered the divisible pool marginally to 41%, from the earlier 42%. The is because Jammu and Kashmir is no longer a state and the money allocated to it has not been counted as transfer to a state government. Given this, the 15th FC has kept the divisible pool distribution unchanged.
And now we come to the most important point of this write up. A key detail in this entire discussion is that the only tax revenue that is excluded from the shared divisible pool are different kinds of surcharges and cess.
As we shall see next, this exclusion has proved to be the back door that the central government has been using to divert funds from the states governments’ kitty to its own.
A Tale of Two Taxes
Before we get into the details, let’s first try and understand what surcharge and cess actually are.
A cess is tax on a tax imposed by the central government attached to a specific purpose. For example, an education cess collected should be utilised only for financing education and not for any other purpose. It is worth remembering here that the education cess is imposed on the total income tax and not on the total taxable income.
Hence, as explained earlier, it is a tax on a tax. Examples include infrastructure cess on petrol and diesel, krishi kalyan cess, health and education cess on Income Tax, etc.
In theory, money collected under a cess is to be spent on the specific purpose for which it is collected but that’s not always the case.
A Comptroller and Auditor General (CAG) report for 2018-19 indicates that only Rs 1.64 lakh crore of the Rs 2.74 lakh crore or around 60% of the amount collected from cess and surcharge during 2018-19 had been transferred to their respective funds. Around 40% was still retained in the Consolidated Fund of India, which is the general-purpose fund of the Indian government.
The provision of levying a cess was intended to be used for shorter specific purposes. So, the procedure for introducing a cess is comparatively simpler than introducing new taxes, which usually require change in the law.
Coming to surcharges, a surcharge is also a tax on a tax, but is not tied to a specific purpose like a cess is. Let’s take the example of the surcharge on income tax. It is an added tax on the taxpayers having a higher taxable income during a particular financial year. So, an individual having a taxable income between Rs 50 Lakhs and Rs 1 crore pays an income tax surcharge of 10%.
Further, an individual with a taxable income between Rs 1 crore and Rs 2 crore, pays an income tax surcharge of 15%, and so on.
Note that this surcharge is only on the base income tax, not on the income itself. So, if an individual earning Rs 1 crore in a year needs to pay an income tax of Rs 20 lakhs, the applicable surcharge would be Rs 2 lakhs (10% of 20 lakhs).
A surcharge can be utilised for any purpose of the government, without having to bend the rules, like they do sometimes for cess collections.
In the last few years, these surcharges and cess, which do not need to be shared with the state governments, have become the central government’s go-to tools to address the tax revenue shortfall.
Take a look at Figure 2a, which basically plots the total amount of surcharges and cess collected by the central government over the years, along with the surcharge and cess it hopes to collect during 2021-22, the current financial year.
Figure 2a: Total cess and surcharge revenue (in Rs crore).
Source: Union budget documents.
Figure 2a clearly shows that the general trend is upwards, with small blips in 2017-18 and 2018-19. The government expects to collect total surcharges and cess of Rs 4,45,822 crore (revised estimate) in 2020-21.
This is surprising given that overall tax collection during the year is expected to come down. In comparison to the years before 2020-21, the collections for 2021-22 are also expected to be at a very high Rs 4,48,821 crore.
The collections of cess and surcharge surged from Rs 2,53,540 crore in 2019-20 to Rs 4,48,822 crore (RE) in 2020-21, an increase of a whopping 77%. This huge increase is almost entirely due to increased cess and surcharge on petrol and diesel – in particular, the road and infrastructure cess and the additional duty of excise on motor spirit (which is a surcharge), which increased by Rs 1,92,792 crore. Motor spirit is the technical term for petrol.
The increased reliance on cess and surcharge is also seen in Figure 2b below, which plots the total cess and surcharge earned by the central government as a proportion of the Indian gross domestic product (GDP). This is done in order to take the size of the Indian economy into account as well.
Figure 2b: Cess and surcharge revenue expressed as a proportion of the GDP (in %).
Source: Union budget documents.
The above figure makes for very interesting reading. The total amount of cess and surcharges earned by the central government went up from 1.25% of the GDP in 2019-20 to 2.29% of the GDP in 2020-21, a massive jump of 104 basis points. Some of this jump was obviously because the size of the economy or the GDP is expected to contract in 2020-21. Nevertheless, the fact that cess and surcharges collected by the government went up in a year when the economy contracted, does come as a surprise.
In Figure 3, let us look at the breakdown between cess and surcharges earned by the central government over the years. Looking at the below figure it is evident that cess collections form the bulk of the total revenue.
Figure 3: Cess and surcharge breakdown (in Rs crore).
Source: Union budget documents.
Clearly, cess is bringing in more money for the central government, though the contribution of surcharges has also jumped up since 2019-20.
Now let’s try and understand, why has the central government increasingly become more dependent on earning money through cess and surcharges, and in the process it is sharing lesser proportion of taxes with the state governments.
This increased reliance on cess and surcharges in the last two years can be understood when one looks at what is happening with the total tax revenue. Figure 4 plots the total taxes earned by the central government or gross tax revenue as a proportion of the GDP.
Figure 4: Gross tax revenue as a proportion of GDP (in %).
Source: Union budget documents
While the negative economic impact of the covid pandemic has been a telling blow, the downward trajectory in tax collections of the central government had started as far as back as 2018-19. The twin economic debacles of PM Modi’s first term – demonetisation and a shaky GST implementation – meant the economy was already tottering before the covid pandemic hit.
An obvious casualty of this slowdown has been a declining tax revenue as a proportion of the GDP. In the normal scheme of things, this would have meant that the central government would have ended up with lesser taxes for itself, after sharing with the state governments.
But this fall has been cushioned with the central government earning a higher amount of taxes through cess and surcharges (as can be seen from Figure 5).
Figure 5: Cess and surcharge as a proportion of total central government taxes.
Source: Union budget Documents RE = Revised Estimate BE = Budget Estimate
In 2019-20, the total taxes earned by the government or the gross tax revenue had stood at Rs 20.1 lakh crore. In 2020-21, it is expected to fall by 5.5% to Rs 19 lakh crore. The net tax revenue of the central government (what remains after sharing taxes with the state governments) in 2019-20 was at Rs 13.59 lakh core.
This is expected to fall to Rs 13.45 lakh crore in 2020-21, a fall of 0.9%, which is much lower than the 5.5% fall in gross tax revenue. While, the total gross tax revenue is expected to fall by Rs 1.1 lakh crore (Rs 20.1 lakh crore minus Rs 19 lakh crore), the net tax revenue is expected to fall by just Rs 14,000 crore (Rs 13.59 lakh crore minus Rs 13.45 lakh crore).
In percentage terms, in 2019-20, the central government kept 67.6% of the taxes for itself in 2019-20. This shot up to 70.8% in 2020-21.
Clearly, the state governments have been short-changed here, with their share of taxes falling from Rs 6.51 lakh crore in 2019-20 to Rs 5.5 lakh crore in 2020-21, a fall of a little over Rs 1 lakh crore or 15.5%, in such economically difficult times.
This is primarily because the share of cess and surcharge in total taxes collected by the central government has jumped from 12.67% in 2019-20 to 23.46% in 2020-21. Do remember that cess and surcharges are outside the divisible pool.
So, when the inflow of these taxes increases, the central government gets to keep all the revenue, as opposed to sharing 41% (15th FC guideline) with the state governments. So, it is far more efficient for the central government to increase cess and surcharge when it needs to increase tax collection.
This overuse of cess and surcharges by the central government has not gone unnoticed. In fact, the chairman of the 15th FC, NK Singh has talked about introducing a constitutional amendment to include them in the divisible pool.
“I see no viable solution except a constitutional amendment. If that constitutional amendment is introduced, recognizing some proportion of cess and surcharge to the divisible pool, it will certainly allow greater flexibility to the successive Finance Commissions subsequently to be able to calibrate a framework.”
Ultimately, as we said at the very beginning, whatever might be the term used, a tax, or a cess or a surcharge for that matter, it is being paid by people. And hence, the money thus collected should be shared with the state governments.
How does all this affect you, dear reader?
If you have managed to make it thus far, many of you by now would be like how much gyan are these guys going to give. Why can’t they tell me straightaway how does all this impact me or the world at large or the aam aadmi?
Well, sometimes it is important to take a look at the bigger picture first and then arrive at how it impacts all of us.
The government’s increased reliance primarily on cess actually has had a direct impact on most citizens – in the form of increased prices at the petrol pump.
The biggest contributor to the spike in cess collection over the last two years has been cess collected on the sale of petroleum products. The figure below charts the total cess collected on petroleum products (crude oil, petrol and diesel) over the last five years. While the cess on petrol formed at least 50% of total cess each year, it was as high as 69% of the total cess revenue in financial years 2019-20 and 2020-21.
Figure 6 clearly shows that the government has resorted to taxing petrol and diesel to make up for revenue shortfalls. This conclusion is hardly a revelation to anyone paying attention to prices at the pump, but the numbers help understand the government’s motivation.
Figure 6: Total cess on petroleum products (in Rs crore).
Source: Union budget documents
There is another way of looking at the cess on petrol and diesel. Table 1 below gives a breakdown of the union taxes on petrol and diesel for 2020-21 and 2021-22. Note that the table below only analyses central excise tax and excludes customs duty. There are technical complications in figuring out the per litre customs duty.
Table 1: Central government tax breakdown on petrol and diesel.
The total union excise duty on petrol and diesel, in 2021-22 are Rs 32.90 per litre and Rs 31.80 per litre, respectively, which are marginally lower than the previous year. All taxes other than basic excise duty, including special additional excise duty, which is a surcharge, are exempt from the divisible pool.
1)For 2021-22, only ~5% of the excise taxes on petrol and diesel will go to the divisible pool. The rest (~95%) will be kept by the central government. In 2020-21, this portion was at around 91% for petrol and 85% for diesel. Clearly, the government is keeping a greater share of petrol and diesel taxes for itself.
2)The above point does not clearly bring out the gravity of the situation. Let’s do a simple calculation to show that. In 2021-22, the total excise duty on petrol stands at Rs 32.90 per litre. Of this, the basic excise duty of Rs 1.4 per litre is the only part which is a part of the divisible pool and hence, will be shared with the states. It is worth remembering only 41% of this or around 57 paisa per litre needs to be shared with the state governments.
What this means is that just 1.7% of the total excise duty earned by the central government per litre of petrol will be shared with the state governments. It was at 3.8% in 2020-21.
3)Now let’s carry out the same exercise for diesel. The total excise duty earned by the central government on the sale of one litre of diesel will be Rs 31.80 during 2021-22. Of this only Rs 1.8 per litre will be shareable with state governments. 41% of this amounts to around 74 paisa per litre.
This amounts to around 2.3% of the total excise duty of Rs 31.8 per litre earned by the central government per litre of diesel. It was at 6.4% in 2020-21.
4)In 2021-22, a new agriculture infra cess has been introduced. It amounts to Rs 2.5 per litre on petrol and Rs 4 per litre on diesel. This has led to the reduction of basic excise duty on petrol from Rs 2.98 per litre to Rs 1.4 per litre and that on diesel from Rs 4.83 per litre to Rs 1.8 litre. As mentioned earlier, only the basic excise duty needs to be shared with the state governments.
Hence, by introducing a new agriculture infra cess, the central government has ensured that state governments get an even lower share of taxes from petrol and diesel in 2021-22.
The general public is quite sensitive to price rise at the petrol pump since it is a highly visible and recurrent cost. That the government has still resorted to this strategy for increasing revenue, speaks to the lack of better options – a fact that is a direct consequence of the tepid economic scenario even before the pandemic began. Of course, the covid pandemic has only made things more difficult for the government on tax front.
Nonetheless, things are even more difficult for state governments, which don’t have many avenues to raise tax. Clearly, this amounts to the centre shortchanging the state governments during difficult economic times.
Oh wait, there is more – Total intergovernmental transfers
Other than the divisible pool of taxes, there are other channels of intergovernmental transfers between the central government and the state governments. So, to get the complete picture on the flow of money from the central government to the state governments, it is instructive to examine the total intergovernmental funds transferred in more detail.
Before diving into those details, a brief overview of intergovernmental transfers would be useful. Figure 7 below is a good graphical representation of all the ways in which the central government can transfer funds to the state governments.
Broadly speaking there are two instruments of fund transfers.
1)Finance Commission funds: As discussed earlier, this includes the 41% of the divisible pool revenue, general-purpose grants for states with weak revenue raising capacity and specific purpose grants for funding local governments (panchayats and municipalities) and funding certain specific initiatives (eg. health-sector grants by the 15th FC). Most of the funds provided via the FC channel are not conditional and don’t require state government contributions.
2)Funds from central ministries: In addition to the FC funds, the central government also gives specific purpose grants through the respective ministries. These funds are transferred either through centrally sponsored schemes or central sector schemes. Central sector schemes are entirely funded by the central government. Some examples include the free LPG connections provided to poor households, crop insurance scheme etc.
The centrally sponsored schemes require a matching component from the state governments i.e. they have to fund a portion of the scheme. Examples of this include the Pradhan Mantri Gram Sadak Yojana, the Swachh Bharat Mission etc.
As Figure 7 shows, the mechanism of intergovernmental transfer underwent a major transformation in 2015. Two things led to this. Firstly, the 14th FC gave its recommendations for increasing the devolution share of state governments from 32% to 42% and eliminating a host of specific purpose grants. The underlying rationale was to change the composition of state transfers to increase the “no-strings-attached” outlays and reduce conditional grants to give state governments more financial headroom.
Secondly, the newly elected NDA government disbanded the Planning Commission and replaced it with the NITI Aayog. While the NITI Aayog has some shades of resemblance with the Planning Commission, the five-year plans, which was the responsibility of the Planning Commission, were scrapped.
The five-year plans would have their own grants for states in the annual budget of the central government. The establishment of the NITI Aayog and the approval of the 14th FC recommendations were two initiatives that formed the basis the oft-cited “cooperative federalism” mantra of the NDA government, especially in the early years.
The argument put forth to claim this catchphrase was that the Modi-led administration was reversing the centralising tendencies of earlier governments and ushering in an environment where states had greater fiscal autonomy.
Does the data corroborate these claims? Let us examine. Figure 8 below charts the tax devolution to states as a portion of the gross tax revenue.
Figure 8: Tax Devolution vs Gross Tax Revenue (in %).
Source: Union budget documents
Some interesting observations can be made from Figure 8.
1)The first few years after the 14th FC came to effect (April 2015) saw a significant increase in the portion of taxes devolved to the states.
2) This increasing trend of devolution peaked in 2018-19 when the devolution was 36.6%. The last three years have seen this number come down, with the 2020-21 figure (~29%) close to the pre-2015 levels. So, all the talk about cooperative federalism has gone for a toss, in the last few years.
3) Note that these numbers don’t reflect the 32% (pre-2015) or 42% (post-2015) devolution share prescribed by the FC since cess and surcharge revenue is not devolved. This also explains why the devolution percentage has dipped sharply in the last two years, a period when cess revenue has had a corresponding increase (as shown earlier in Figure 5).
While the 14th FC may have been the catalyst, the Modi government can rightfully claim credit for strengthening fiscal federalism, at least in its first term. However, most of these gains have been reversed in their second term. This justifies N.K Singh’s lament:
“ It should not be a cat and mouse game that every finance commission raises the devolution number and it then neutralised simultaneously by an increase in cess and surcharge leaving the states where they were, nor the opposite way.”
Next, in Figure 9, let us look at the total transfers made to state governments in recent years, not just tax devolution. The total transfers to states includes tax devolution, finance commission grants, centrally sponsored schemes, central sector schemes and other miscellaneous items listed as state transfers in the union budget.
The figure below charts the total transfers made to states as a percent of the total expenditure of the Union government.
Figure 9: Portion of total expenditure of central government transferred to state governments (in %).
Source: Union budget documents
There are two caveats on the chart above.
1)Starting 2014-15 there was a change in how expenditure for central schemes was routed to the states. The figures for 2013-14 have been adjusted to make the comparisons with the subsequent years correctly.
2) We have excluded loans made to states from the total transfer amounts and only included grants and devolution, since loans do need to be repaid.
That said, these figures also lead to similar observations made from Figure 8. The period from 2015-16 to 2018-19 (roughly co-incident with NDA’s first term) had a significant increase in funding to the state governments.
While the increased devolution of taxes could be attributed to the recommendations of the 14th FC, the increase in total transfer of funds was certainly government policy. The last two years (and the projections for the next year) show a steep decline in the intergovernmental transfers. The huge spike in cess and surcharge collections which are not shared with states and declining tax revenues during this period contributed to this effect.
There are two other conjectures one can make based on the trends seen above. First, when Narendra Modi won in May 2014, he was a sitting chief minister and his perspective on governance was heavily biased towards the challenges of governing a state.
Hence, financial outlays were perhaps favourable to the states. In the second term, he was well-entrenched as a national leader and the instincts were now honed favouring centralisation.
Second, the Bhartiya Janata Party has adopted an increasingly overt approach favouring homogenisation of the country. Whether it is the abrogation of Article 370, the passage of national farm laws, or flirtations with one-nation-one-language, it is evident that impulse is towards uniformity and centralisation. In this context, the trend of holding back funds from states, seems a natural accompaniment.
Summary: I went looking for the legal reasons being offered by the central government to not compensate the state governments for the dramatic fall in GST collections. I found a central government paper explaining the logic with a lot of legalese. This piece tries to summarise the legalese in simple English. Along with that, I offer many reasons as to why the central government needs to adequately compensate the states. This is definitely not something you will read in the mainstream media.
As has been reported almost everywhere by now, the central government doesn’t want to compensate the state governments for a shortfall in goods and services tax (GST) collections that is going to happen through this year.
In an earlier piece I had explained why this was a bad decision. In today’s piece we will try and understand the central government’s reasoning behind this decision, at the same time we shall also see why the central government is in a much better position to deal with the situation than states are. The Story So Far
The GST collections between April and June this year have been around 34.5% lower at Rs 2.73 lakh crore than during the same period in July 2019. As the economy contracts in the aftermath of covid-19, the collections will continue to remain subdued during the remaining part of the year.
The central government needs to share a significant part of the GST with the state governments. Over and above this, there is also a guarantee of 14% growth in GST collections for states for the first five years until 2022. If this is not achieved, the central government needs to compensate the state governments for any shortfall. The central government has decided not to do so. The Legalese
This public paper explains the central government’s position on the issue. Let’s see why the government is saying what it is saying.
The Constitution (101st Amendment) Act 2016 contains the following provision:
“Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax [emphasis added] for a period of five years.”
Following the above provision, the Parliament enacted the Goods and Services Tax (Compensation to States) Act 2017. The preamble of this Act reads as follows:
“An Act to provide for compensation to the States for the loss of revenue arising on account of implementation of the goods and services tax [emphasis added] in pursuance of the provisions of the Constitution (One Hundred and First Amendment) Act.”
In fact, the emphasised parts (in bold italics) in both the 101st amendment as well as the Goods and Services Tax (Compensation to States) Act 2017, read exactly the same. What does this mean in simple English? It means that state governments will be provided a compensation if there is a loss of revenue on account of problems with the implementation of GST (of course, there have been problems galore, but let’s not go there now).
Hence, the central government could have used this technicality in denying the state governments any compensation for a fall in GST collections.
As the policy paper referred to earlier points out: “The Constitution and the preamble to the Act lay out the spirit and purpose of the GST compensation: namely that it is to compensate states for loss of revenue “arising on account of implementation of GST”. The wording of the Constitution and statutory preamble make it clear that the spirit of the law is not to compensate states for all types of revenue losses, but rather for that loss arising from GST implementation.” Ultimately, the GST collections in 2020-21 will fall majorly because of the negative economic impact of the covid-19 pandemic and not just because of the loss of revenue thanks to the botched up implementation of the GST by the central government.
The interesting thing is that the government hasn’t used the above explanation to deny compensating the states for the GST shortfall. It has gone deeper into the legalese to deny the states a compensation.
But before we get into that, the central government has this to say about the GST shortfall: “Parliament obviously could not have contemplated a historically unprecedented situation of huge losses of revenue [thanks to the spread of covid-19] from the base—arising from an Act of God [emphasis added] quite independently of GST implementation—affecting both Central and State revenues, direct and indirect.”
This is where the act of god phrase came into being, also telling us that the government doesn’t do or say anything without putting it on kagaz [paper] first.
Now let’s get back to why the government has denied compensating the states for the GST shortfall. The Section 7 of the the Goods and Services Tax (Compensation to States) Act 2017, provides the detailed mechanism for the calculation as well as the payment of compensation to the state governments when there is a shortfall.
Nevertheless, Section 7 doesn’t make any distinction between the shortfall in GST collections happening due to implementations reasons and non-implementation reasons. As the government paper points out: “Compensation is payable for the entire shortfall (even if it is not on account of GST implementation). This position has been clarified by the Attorney General and is accepted by the Central Government [emphasis in the original].”
So, if this interpretation has been accepted by the central government, why isn’t it compensating the state governments? If your head is already spinning by now, I don’t blame you for it. The legalese behind which the central government is hiding keeps getting better. Let’s move ahead.
The Section 10 of the Goods and Services Tax (Compensation to States) Act 2017 prescribes the manner of payment of the compensation to state governments in case of a shortfall. Let’s look at this pointwise.
1) The compensation is to be paid out of the non-lapsable GST Compensation Fund.
2) Money flows into the GST Compensation Fund from the GST Compensation Cess levied on sin and luxury goods under Section 8, which includes everything from cigarettes to expensive cars. This is made clear under Section 10(1).
3) Section 10(1) also makes it clear that money can flow into the GST Compensation Fund through “such other amounts as may be recommended by the Council”. Hence, other than the GST Compensation Cess only something cleared by the Council can flow into the GST Compensation Fund.
4) Section 10(2) says that compensation under Section 7 “shall be paid out of the Fund”.
Basically, what the government is saying here is that any compensation to state governments on account of a loss of revenue needs to be paid out of the GST Compensation Fund.
So, the government summarises its position by saying: “The states are entitled to compensation…regardless of the cause of the shortfall. However, compensation is to be paid only from the Compensation Fund and it is not an obligation of the Government of India in the event of a shortfall. It is for the GST Council to decide on the mode of making good the shortfall.”
Of course, with the GST collections falling, the compensation cess will not be enough to make up for the shortfall. Also, what the central government is saying is that the GST Council is a different entity from it. This is the point being made on the basis of some complicated legalese. And this rather complicated legalese has been used to basically shaft, for the lack of a better word, the state governments. The central government paper also talks about the spirit of the law.
As far as the act of god point goes, if a fall in GST collections due to covid-19 is act of god for the central government, it is also an act of god for the state governments as well. What are they expected to do in such a scenario?
And given that, the law needs to be changed, simply because the facts have changed and the situation that has arisen currently wasn’t taken into account when the law was first framed. If every law was perfect as it was written first time around, there wouldn’t be so many amendments going around. As the famous British economist, John Maynard Keynes, once supposedly said: “When the facts change, I change my mind. What do you do, sir?” The Central Government Needs to Compensate
The central government needs to compensate the state governments for this shortfall in GST collections. The state governments are at the forefront of fighting the pandemic and hence, need money. Also, state governments spend more money than the central government during the course of any year and that needs to be kept in mind as well, in a scenario, where the private expenditure has collapsed dramatically post covid.
Also, as the government paper points out: “The notion of borrowing by the GST Council is not practically or legally feasible or desirable. This leaves the options of Central or state borrowing.” Let’s look at what the central government is offering the states as a compensation.
1) The shortfall arising out of the loss of revenue due to the GST implementation has been estimated by the central government to be at Rs 97,000 crore. The state governments can borrow this money under a special window coordinated by the finance ministry. The states can repay both principal and interest by using the money they receive from the compensation cess. Also, this borrowing shall not be treated as debt. Hence, it will not limit any state’s overall borrowing ability.
2) The overall shortfall (thanks to implementation and covid impact) in GST collections has been estimated to be at Rs 2.35 lakh crore. The state governments can borrow this entire amount from the market. An amount of Rs 1.38 lakh crore (Rs 2.35 lakh crore minus Rs 97,000 crore) will be considered to be as debt of the state governments. The state governments will have to repay this debt from their own resources. They can repay the principle from the compensation cess.
The government’s logic in getting states to borrow directly from the market is rather bizarre. Nevertheless, let’s take a look at this.
This is what the government paper says: “The Government of India faces a very large borrowing requirement this year. Additional borrowing by the Centre influences the yields on Central government securities (g-secs) and has other macro-economic repercussions. The yield on G-secs acts as a benchmark for State borrowing as well as private sector borrowing. Hence any rise in Central borrowing costs ipso facto drives up borrowing costs for all borrowers, including not only the States but also the entire private sector. On the other hand, the yields on State Government securities do not directly influence other yields and do not have the same type of macroeconomic repercussions.”
What does this mean in simple English (now how many times will I end up saying this)? The central government will end up borrowing more this year than in other years. In this scenario, it will end up needing a greater amount of financial savings to fund itself. This will push up interest rates at which the central government borrows. When the rate of interest at which the central government borrows goes up, the rate of interest for the entire financial system goes up because lending to the central government is the safest form of lending. When this happens, both the private sector as well as the state governments will end up paying higher interest rates on the money they borrow.
The central government’s contention is that the above logic does not apply to when state governments borrow. Their borrowing doesn’t end up pushing overall interest rates.
This is bizarre to say the least. If the state government borrows more from the same pool of savings, it will end up pushing the overall interest rates in the financial system, upwards.
The question is why doesn’t the central government want to borrow more. The government originally expected to borrow Rs 7.8 lakh crore to finance its fiscal deficit in 2020-21. Fiscal deficit is the difference between what a government earns and what it spends. This has already been increased by more than 50% to Rs 12 lakh crore. Any further borrowing will mean, the central government’s already terrible numbers on the fiscal front, will end up looking even more terrible.
I guess that is the logic running in the minds of the babus at the finance ministry and their minister. The trouble is this logic doesn’t hold. Irrespective who borrows, the state governments or the central government, the public debt or the overall debt of the public sector, will go up. Further, there is an implicit sovereign guarantee on state government debt.
As Shaktikanta Das, the governor of the RBI said in November 2019: “There is an implicit sovereign guarantee in them… On the due date of repayment, RBI automatically debits the state government account and makes the repayment. So, there is an implicit sovereign guarantee.” Hence, ultimately, if there is any trouble on this front, it is the central government’s problem.
Further, the central government is in a much better position to raise money. It can sell its stakes in public sector enterprises. It can also sell their land. It has access to a variety of cesses (tax on tax) from which it can earn money. This is money it doesn’t need to share with state governments. It also has access to the profit made by the Reserve Bank of India, as well as its reserves. The ability of the state governments to tax post GST has come down.
Also, various central government institutions (from banks to insurance companies) end up buying bonds issued by the state governments. In that sense the interest on these bonds gets paid to them. The profits made by these institutions end up with the central government, one way or another (corporate income tax/dividends/special dividends etc.).
Hence, there are many reasons as to why the central government should compensate the state governments for a fall in GST collections. But the biggest reason as the deputy chief minister of Bihar, Sushil Modi told the the Press Trust of India: “It is the commitment of the central government to compensate the states for the shortfall in GST collections. It’s true that it is legally not binding on the Centre, but morally, it is.”