India's Tax Cut Proposal Sparks Centre-State Fiscal Tensions

Prime Minister Narendra Modi's surprise move to reduce consumption taxes within three months is set to spark tough negotiations with states, who will need to shoulder the loss of revenue.

PM Modi's GST Reforms

PM Modi had proposed a major rejig of the complex goods and services tax last week, which was a move that several businesses had been pushing for since the system was rolled out in 2017.

The stocks rallied as investors were betting lower taxes on everyday goods would boost consumer spending and help offset the drag on economic growth from higher US tariffs.

Additionally, the tax proposals which still need to be approved - are expected to squeeze the government's revenue, especially for state governments.

According to a report by Bloomberg, economists like Gaura Sen Gupta at IDFC First Bank estimate the total cost to the exchequer at Rs 1.8 lakh crore ($20.7 billion) annually, with the federal government facing a net revenue hit of about 0.15% of the gross domestic product and states incurring losses of roughly 0.36% of GDP.

This uneven hit is likely to sharpen fiscal tensions between New Delhi and the states, which have sparred with Modi's government over revenue-sharing in the past.

State Governments' Grievance

As per the report, certain states say they were not adequately compensated for losses when the GST was introduced, leaving them with limited ways to raise revenue on their own.

According to Harpal Singh Cheema, the finance minister of Punjab, his state has been losing 210 billion rupees annually since the introduction of the GST, so he called for a new mechanism to compensate states for such losses, he told reporters on Wednesday.

Wealthier opposition-ruled southern states have also long argued that much of the tax revenue they generate is diverted north, where Modi’s ruling party holds greater sway.

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