Demonetization – Building Allies vs Forcing into Action

Ever since the demonetization decision was made public by the Union Government of India, on the 8th of November 2016, lot has been discussed about the pros and cons of the measure. However, not much has been discussed about the measure from the federalism angle. In this article, we try to look at the whole demonetization exercise from the federalism point of view.

Taxation Powers in a Federal Polity
In many mature democracies, the taxation powers are distributed between the states and the union (also called as ‘federal’) governments. Not just the indirect taxes, even the direct taxes like Income tax and Corporate tax powers are with the state governments too. In federal polities like USA, Canada or Australia, this is the norm.

In India however, the powers to levy direct taxes rest solely with the Union Government. This in itself is, over-centralization of powers. When nations like Canada and Australia with population of 20-30 million take fiscal federalism seriously, what stops the highly diverse nation with a population of 1.25 billion from taking fiscal federalism seriously?

The Black Money
In the previous paragraphs, we discussed about direct taxation powers. Because by definition, black money is the amount for which direct tax has not been paid. By retaining the power to levy direct taxes, the union government has kept to itself all the incentives to fight tax evasion. Had the state governments been provided with direct taxation powers, as is the case in mature democracies, the union would have found natural allies in all the state governments in the fight against tax evasion.

Building Allies vs Forcing into Action
The current approach, taken by the Union Government to catch tax evaders, is more like ‘Forcing’ the state governments into action. Quite naturally, when something is forced upon someone, the reluctance levels will be high and enthusiasm levels will be low. Needless to add, that in a federal setup, such moves are against the fundamental principles of federalism. The frequently heard term of “co-operative federalism” appears to be lacking any substance, considering the current approach.

For co-operation between any two elected governments, there must be an incentive at play. Had the direct taxation powers been in concurrent list, the resulting bounty from the fight against tax evasion would have been an incentive, for both the union and the state governments. To tackle tax evasion, whether it is the USA working with Switzerland, or Germany working with Panama, the approach one can see is that of ‘carrot & stick’. That is how co-operation is achieved, and is made effective. “Stick alone” approach, doesn’t build a strong and effective co-operation.

The demonetization exercise by the union government is akin to “stick-only” approach, and is evident that there was no effort to build consensus among the state governments and the union. This one exercise has strained the federalism-fabric so much, that we might start hearing the benefits of common currency across the union of India being questioned.

Centre State Investment Agreement and Its Impression on Federalism in India

- Rakshith Ponnathpur.

Finance Minister Arun Jaitley, in this year’s Annual Budget, proposed for an agreement to be signed between the Union and the states to facilitate smooth implementation of Bilateral Investment Treaties (BITs) that India is set to enter into with the nations of the world, replacing the existing Bilateral Investment Protection and Promotion Agreements (BIPPAs). While signing this agreement is not mandatory, the perception that states which sign the agreement are better investment destinations than states which do not, will serve as an incentive for the states to sign the agreement.

The primary objective of the Centre-State Investment Agreement (CSIA), as the agreement is called, is to ensure fulfillment of state governments’ obligations under these bilateral treaties. Many a time, investors feel cheated because of a state’s failure to fulfill the promises made by the Union while signing the agreements. But signing the CSIA will bind the states to fulfill their commitments, bringing in some accountability into the whole business. CSIA is the first such move to actually involve the states in an area which has been exclusively Union's realm so far.

However, critics rightly argue that CSIA will have very little legal significance should investors approach international courts for arbitration. Irrespective of any agreements signed between the Government of India and its states, only the former can be held liable and accountable externally. This is because only the Union Government has the power to enter into treaties on behalf of the Indian Republic and once it has acceded to its terms, the international obligations assumed thereunder bind the entire country and not any individual states. CSIA can only facilitate shifting of blame for the embarrassment from the Union to the states internally.

The introduction of this agreement will also impact federalism in India, an area which clearly does not feature among the strong points of Indian polity. The states will not particularly be impressed with yet another provision which will enable Delhi to shift the blame to their capitals. Creation of a negative perception about a state’s investment ecosystem should it excuse itself from signing the agreement and Union's plans to inform investors beforehand about states which have not signed the CSIA will further make the states feel that the agreement is unfair on them, which is understandable since the states have little say in the provisions of the bilateral treaties itself in the first place.

A solution for this would be to institutionalize the involvement of state governments in the treaty-making process. The states will not find the CSIA unfair if they themselves are involved in formulation of the provisions of these treaties. The Chief Ministers of states can be made members of a consultative commission on treaty making (like the Governing Council of Niti Aayog) and this need not just be restricted to investment treaties, but can also be extended to other international agreements like the WTO treaty, Free Trade Agreements and Double Taxation Avoidance Agreements. Many of these agreements involve domains like agriculture which fall under the State List and directly impact the states, and it would only be logical on the part of Union Government to include actual stakeholders.

CSIA featured in discussions held at the recent Inter-State Council Meeting, with Tamil Nadu Chief Minister Jayalalitha welcoming the Union's move to include states in the treaty-making process and also raising some of her reservations about the draft CSIA agreement. There is a possibility that the Union might try to pass on some financial burdens it might suffer from penalties under already existing bilateral agreements, which she feels is unfair since states are neither party nor aware of the provisions of earlier treaties. She also expressed her concern that the Union deducting such dues from the amount it transfers to states, would impact the implementation of schemes of state governments, and called for the deletion of the provision which enables the Union Government to resort to this practice.

Centre State Investment Agreement will be a commendable and an affirmative step, which will help in bringing some much needed order, accountability and cooperation between the Union and the states in smooth implementation of bilateral treaties, provided it makes the Union and the states part of the holistic treatyformulation process. Otherwise, it may well go on to be yet another provision which makes states liable to the shortcomings of provisions they were not even aware of, in the first place.

This is a golden opportunity for the Union Government to show it means no nonsense when it talks of cooperative federalism, and include states as equally responsible stakeholders in foreign investment.

GST: What it Means to Federalism in the Indian Union

The Goods and Services Tax is being sold as the best thing that could happen to the system of indirect taxes in the history of the Indian Union. Simplification and streamlining of taxes, uniform taxation across the union, one integrated market, multitude of opportunities to leverage economies of scale, boost to the GDP and significance to the Make in India initiative - the benefits, we are told, are astounding. But what does it mean to the states and their diverse peoples?

A brief history of GST in the Indian Union
 
To begin with, let us look at the history of GST. The proposal was first made in the Union Budget speech of 2006-07. None of the states had asked for it in the first place. The Union Government, nevertheless, wanted to roll out a national-level GST. Meaning, indirect taxes like excise duty, additional excise duty, service tax etc., that fall under the purview of the Union Government, and sales tax, purchase tax, entry tax, entertainment tax etc., that come under the state governments would be subsumed under one national-level tax structure, and that would have no state component. So, the States would get no revenue from goods and services; instead the Union would own and collect all taxes and redistribute among the States.

It was then handed off to the Empowered Committee of Finance Ministers to lay the road-map for its implementation across the Union. Since there was representation of the states in the committee, the idea of national-level GST was opposed. Which state would want to lose its revenues or even the control over its revenues? Finally, a compromise was reached with the dual-GST model, which included a state component too. But as we will see further, the compromise does not necessarily restore control back to the states.

GST - Thrust upon unwilling states

The idea of GST - whether a national level GST, as it was to start with, or a dual GST, as it is being proposed as a compromise now - has come top down from the Union to the States. The States have only agreed to it as a compromise and never wanted such a structure in place. When the States did not want what gave the Union the legitimacy to impose a new taxation structure on them? Note that by legitimacy I do not mean Constitutional legitimacy; I am rather questioning the invasive and imperious attitude of the Union Government in a federal setup comprising several diverse states, each with its unique history, culture, issues and state of socio-economic development.

The AIADMK rightly pointed out the effect the GST Bill will have on the autonomy of the states. In a dissent note the party observed:

..the GST Council, as a constitutional body, impinged on the legislative sovereignty of both Parliament and the State legislature and would jeopardise the autonomy of the States in fiscal matters.

The GST Council will be setup with the passage of the Goods and Services Tax Bill. It will be headed by the Union Finance Minister with the state Finance Ministers as its members. This council will be responsible for the categorization of goods and services, and will decide the tax rates on the same. In matters pertaining to taxes and revenues, all States in the Union should abide by its orders and decisions. What democratic legitimacy and credibility will an elected body retain, when its own matters are decided by a superseding external council that is nominated? The concerns of sovereignty and autonomy of the States, expressed by the AIADMK are absolutely relevant.

No doubt, there is representation of the states in the council. The council, as already stated, will have state Finance Ministers as members. But the weightage given to the states is something to be noted. The Union Government has decided to hold a weightage of one-third of the total votes for itself, and has given two-thirds' weightage to all the states put together. With this, the Union has ensured it has veto power of sorts for itself in the council. The States, needless to say will be dummies. Barring a few exceptional cases in which a majority of States may come to a common agreement, this setup ensures the Union has total control in all matters of indirect taxation in the country.

The GST Council is anti-Federal
 
States that are ruled by the so called 'national' parties, usually have to toe the line of their party high-command, whose agenda is primarily focused on holding the reins of power at Delhi. The interest of the people of the State comes next to this agenda. While this will tilt the balance of power more in favour of the Union Government, those States with less influence in the Union and those ruled by state-level parties will find it much harder to influence any decisions in their favour.

It is also being said that the States can appeal to the council. But a democratically elected government going to a council for matters such as its own taxes and revenues is fundamentally opposed to the idea of democracy and federalism. A legislature elected by the people should hold these powers, not a council or a committee. It also becomes much tougher for the states to come up with and roll out any new or innovative economic policies. They all will have to operate within the limits imposed by this one framework decided by the council.

Who will really benefit from economies of scale?

I also want to address the argument of integrated market and economies of scale. Who does this benefit? It certainly benefits businesses and enterprises that are well established and have large scale inter-state operations. But what if the states want to take a different approach to nurture local entrepreneurship, for example? What autonomy will they be left with to roll-out an economic policy favouring local entrepreneurship when a uniform framework is already decided by and rolled out from a committee sitting in a far-off Delhi?

 Do we really need an integrated market? Do we really need economies of scale? Can our people leverage the so-called economies of scale effectively? These are questions that each state and its people should discuss, debate and take decisions on. Rolling out from Delhi, a single policy for diverse peoples, makes little sense. In fact, it comes with the attitude of 'I know what you need better than you do' - violating the fundamentals of free choice, liberty and democracy.

By this I do not want to sound like a conservative opposed to economic progress. In fact, in today's world, free and democratic countries have attained much stable and viable economic progress in comparison to autocratic, dictatorial or less democratic ones. The USA, termed as the epitome of free- market economy does not have a unified, integrated market. The sales taxes vary across states. In states like Alabama, Oregon, New Hampshire etc., there is no sales tax at all. In contrast, California has the highest rate of sales tax. These rates are decided by the States themselves, the Federal Government has little say in it. To add to it, the cities, the counties and other local bodies may levy additional taxes.  It is not just sales taxes, the States have their share of income tax as well, which is totally a Union subject in India. The USA has shown that a free market does not necessarily have to compromise on liberty of its people or the autonomy of its states.

Another argument in favour of GST is the ease of doing business in India, as businesses do not have to deal with different tax structures in different states. This argument too does not hold any water, when you look at countries like the United States. Despite different laws and taxation structure across different states, USA is way ahead of the Indian Union in this parameter.

Lot is being said about federalism, particularly co-operative federalism, of late. But the GST in its current form will be disastrous to the autonomy of states and the overall federal setup of the Indian Union. Here is a video recording of a talk on the same subject that I gave at Total Kannada, Jayanagar, Bengaluru, on the 13th of March. In this talk, which is in Kannada, I make the same arguments of democracy, federalism and liberty in purview of the GST bill. Comments / feedback/ discussion welcome.

A Talk on GST and Federalism

Goods and Services Tax (GST) has been one of the most debated subjects in the last several months. The introduction of GST is expected to streamline levying and collection of indirect taxes on the supply of goods and services in the Indian Union by being a comprehensive tax that will subsume several other taxes levied by both the Union and the states. By reducing the cascading effect of taxes at every stage of supply, it is expected to reduce the burden of tax, and benefit the industry as well as the common consumer. While its expected benefits are still being debated, I would like to explore the much less talked about implications of the GST: What does GST mean to the federal setup of the Indian Union? What does it mean to the Union-states relationship? What does it mean to the fiscal autonomy of the states?

Join me for a talk on this subject on Sunday, the 13th of March 2016, at Total Kannada, Jayanagar, Bengaluru. The talk titled 'GST in India's Federal System' will be in Kannada. The details of the event are here in this Facebook event invite, please confirm your presence if you are interested to attend the talk: https://www.facebook.com/events/742957599174859/

Below Replacement-Level TFR of Non-Hindi States – Why the Union Government Must Act Now

Krishna Gopal, joint secretary of the RSS, in a briefing to the media has expressed concerns over impending 'demographic imbalance' in India. Hence, he has urged the Union Government to reformulate the National Population Policy. Here is an excerpt from the press report in DNA that had covered this in more detail:

The policy, he said, aimed at achieving a stable but healthy population by 2045 by optimising the fertility rate to the ideal figure of 2.1 total fertility rate (TFR) and it was expected that it would be applied uniformly to all sections of the society as this aim was in accordance with the national resources and expected future requirements.

However, the National Fertility & Health Survey (NFHS) of 2005-06 and the 0-6 age group population percentage data of religion in Census 2011, both indicate that the TFR and child ratio "is uneven across the religions", he said. 

Krishna Gopal is right in saying that the fertility rates should be uniform across all sections of the society, and uneven TFRs may lead to serious demographic imbalances. If India aims to achieve the ideal fertility rate of 2.1, it is necessary that all sections of the society uniformly achieve fertility rates of 2.1.

While the RSS’s concern for uneven TFR and the resulting demographic imbalance is based on religious parameters, it is equally important to consider regional and linguistic parameters in the population equation. For, the Union of India is not only diverse in terms of religions but also linguistically and culturally diverse, and such consideration is important. So, let us consider the past TFRs (2007), TFR goals for the eleventh five year plan (2007-12), and the latest available TFR data of some of the states of the Indian Union.

State	Fertility Rate 2007	Eleventh Five Year Plan Target (2012)	Fertility Rate 2013
West Bengal	2.2	1.8	1.6
Punjab	2.2	1.8	1.7
Tamil Nadu	1.8	1.7	1.7
Andhra Pradesh	2.1	1.8	1.8
Maharashtra	2.2	1.9	1.8
Karnataka	2.3	1.8	1.9
Gujarat	2.8	2.2	2.3
Madhya Pradesh	3.7	2.6	2.9
Uttar Pradesh	4.4	3.0	3.1
Bihar	4.3	3.0	3.4

 

As can be seen from the above table, many states were given TFR goals well below 2.1 for the eleventh five-year plan. On what basis did the Planning Commission set TFR targets below 2.1, to states like West Bengal, Punjab, Tamil Nadu, Karnataka etc.? Was not the Planning Commission aware that such targets are unscientific and can lead to large demographic imbalances when it set them? Didn’t the planning commission know that TFR below 2.1 is suicidal to any community? Or was it deliberate?

Incompetence or deliberation, such an act by a ‘national’ institute of such repute will be interpreted as an unethical one and will lead to mistrust in India’s federal setup.

It seems, the twelfth five year plan (2012-2017) too has not considered the state-wise uneven TFRs, especially those falling below the replacement levels. In reviewing the goals accomplished in the eleventh five year plan, the twelfth plan makes an interesting observation –

Replacement level TFR, namely 2.1, has been attained by nine states. High fertility remains a problem in seven States…

In reality, those nine states namely, West Bengal, Punjab, Himachal Pradesh, Tamil Nadu, Kerala, Andhra Pradesh, Maharashtra, Karnataka and Jammu and Kashmir, have not just achieved a replacement level TFR of 2.1, but they are actually dangerously slipping below that level. And this is all by plan.

The twelfth plan does not alarm these states of their dropping TFR levels, but has set an overall target for India at 2.1, which it aims to achieve by 2017. On the reduction of India’s TFR to 2.1 the planning commission says:

 India is on track for the achievement of a TFR target of 2.1 by 2017, which is necessary to achieve net replacement level of unity, and realise the long cherished goal of the National Health Policy, 1983 and National Population Policy of 2000

How will this be achieved? As is evident, it will not be achieved by maintaining a healthy TFR of 2.1 across all member states and demography of the Union. It will be achieved by further slumping the TFRs of the Kannadigas, the Tamils, the Marathis, the Bengalis and the Punjabis, whose fertility rates are already well below replacement levels. Whereas the population of states like Bihar, Madhya Pradesh and Uttar Pradesh will continue to grow.

Just last week, China announced a shift from its decades-old one-child policy to a two-child policy in the wake of decreasing TFR and ageing population. If RSS is sincerely concerned about all the peoples of India, represented by diverse languages and cultures, it should also consider uneven and falling TFR levels of the above mentioned regions seriously. It is its political associate, the BJP, which currently holds the reins of power at New Delhi. So, the RSS should to take up the issue with the Government of India. At the same time, the NDA government should earnestly work towards getting the fertility rate of these non-Hindi states upwards to 2.1.