Unit 2

GST Reforms and Intergovernmental Considerations in India by Satya Poddar Ehtisham Ahmad

Introduction

The paper starts by explaining how India began to improve its indirect tax system with the
introduction of State VAT in 2005. Before VAT, the sales tax system in India was very complicated
and inefficient, and it was often described as one of the most complex systems in the world. This
made taxation difficult to understand and manage.

The move toward VAT was guided by Dr. Asim Dasgupta, who was the Chairperson of the
Empowered Committee of State Finance Ministers. The idea of introducing VAT did not come
suddenly. Earlier, in 1994, the Bagchi Report, prepared by a team led by Dr. Amaresh Bagchi of
NIPFP, had suggested State VAT as a practical reform that could fit within India’s constitutional
framework. Although VAT was not a perfect system, it was seen as an important step toward
creating a more logical and organized tax structure.

Encouraged by the success of State VAT, both the Centre and the States then began discussions on
creating a more comprehensive tax system called the Goods and Services Tax (GST). In November
2007, the Empowered Committee announced that India would adopt a Dual GST system, where both
the Centre and the States would have the power to levy GST at the same time. However, at that
stage, many aspects of how this dual GST would work were still unclear.

The paper therefore focuses on examining these unresolved issues. It looks at why GST was needed,
how the tax reform should be structured, possible alternatives to the dual GST model, and how GST
should treat areas such as food, housing, services, and inter-state transactions. It also discusses the
difficulties involved in harmonizing the system across different levels of government.

Shortcomings of the Existing Tax System

GST was planned to replace three main taxes:

 CENVAT and Service Tax collected by the Centre

 VAT collected by the States

Even though some improvements were made earlier—like moving from single-point sales tax to VAT,
lowering CST, and simplifying CENVAT—many problems still remained.

The biggest problem came from the constitutional division of tax powers:

 The Centre could tax goods only at the manufacturing stage.

 The States could tax only the sale and purchase of goods.
 Neither could tax the full value chain of goods and services.

This divided system caused inefficiency, distortions, and tax cascading.

The first major weakness was taxing manufacturing only.

CENVAT applies only at the manufacturing stage.

It is difficult to define what counts as “manufacturing” and how to value it.

Manufacturing is only a small part of the value chain, so the tax base becomes narrow.
The tax burden changes depending on how the supply chain is organized.

Many countries have abandoned manufacturing-stage taxes because they do not work well.

Australia is given as an example where such a tax was replaced by GST.

The second problem was that States could not tax services.

This caused issues in transactions involving both goods and services, like works contracts or leasing.

Since goods and services are now closely linked, this restriction led to disputes and distortions.

The third problem was tax cascading.

The credit chain breaks because the Centre and States tax different stages.

Input taxes cannot always be fully credited, so tax is paid on tax.

This increases costs, reduces competitiveness, and pushes firms to reorganize production to avoid
tax.

The fourth issue was complexity.

CENVAT has many rates and complicated valuation rules.

Service Tax uses a long list with nearly 100 service categories, leading to disputes.

There is no standard way to classify services.

State VAT systems still differ because of exemptions, thresholds, and variations across states.

Because of all these problems, the authors argue that a comprehensive GST covering all goods and
services across the entire supply chain is the most logical next step.

Objectives of Tax Reform

The paper explains that tax reform has three main objectives:

 Basic economic objectives

 Harmonization
 Division of powers between the Centre and the States
 The basic economic objectives include neutrality, simplicity, efficiency, and good revenue
collection.
 A well-designed GST should have one single rate applied to a wide range of goods and
services so that the tax system does not distort business decisions.
 GST should be simple to follow, with low compliance costs for taxpayers and lower
administrative work for the government.
 It should remove tax cascading, meaning tax should not be charged on tax, and this should
help improve competitiveness.
 GST should encourage voluntary compliance, so people willingly pay taxes, which increases
revenue without raising tax rates.
 The paper refers to New Zealand and Canada as examples where a broad-based GST has
worked well.

The second objective focuses on fiscal autonomy and harmonization.

In a federal country, both the Centre and the States want control over tax policy, including the
power to make tax laws, collect money, manage risks, and design policies for social and economic
goals.

However, if States have too much autonomy, it can break the unity of the national market.

The paper mentions China and Australia as countries where centralized VAT systems worked
successfully with revenue sharing.

In India, such centralization is politically difficult, because States want to keep control over taxation.

Therefore, the real challenge is to balance autonomy with harmonization.

Harmonization is needed to prevent problems in inter-state trade, lower compliance costs for
businesses, and reduce administrative complexity.

Harmonization means aligning tax rates, the tax base, and administrative procedures across states.

Even though countries have different tax policies, the authors say that a common tax base and
coordinated rules are needed to reduce confusion.

The third objective concerns the constitutional division of powers.

GST requires changes because both the Centre and the States must have the power to tax goods and
services across the full supply chain, which the existing Constitution did not allow.

Options for Centre and State GSTs

The paper explains that there are four possible models for introducing GST in India:

 concurrent dual GST,

 national GST,
 State GST,
 and non-concurrent dual VAT

. Among these, the concurrent dual GST has already been approved by the Empowered Committee.
Under this model, both the Centre and the States levy GST on the same base of goods and services,
which helps preserve the fiscal autonomy of both levels of government. However, this system
requires a constitutional amendment to allow States to tax services and the Centre to tax retail sales.
It also demands strong harmonization of laws, rules, and administrative systems across the country.
One major challenge under this model is deciding the place of taxation for inter-state services, since
services do not have a fixed physical location.

The national GST model proposes a single GST administered by the Centre, with revenues shared
between the Centre and the States. This option would simplify administration, reduce duplication,
and lower costs. However, it requires States to give up their taxation powers, which they are
unwilling to do. It would also lead to unequal revenue outcomes, as richer States would gain more
while poorer States would lose transfers, making the reform politically difficult. Additionally, limiting
the Centre’s role in inter-state taxation could weaken the basis for uniform taxation of goods and
services across state borders.

Under the State GST model, States would have complete authority to levy GST on goods and services
within their territories, and the Centre would withdraw from domestic consumption taxes. While
this increases State autonomy, it seriously weakens harmonization and creates practical difficulties
in managing inter-state transactions and monitoring cross-border services. The non-concurrent dual
VAT model suggests that the Centre should tax only services and States should tax only goods,
avoiding the need for constitutional amendments. However, this approach continues many existing
problems such as tax cascading and the separation of goods and services, and it goes against the
core objectives of GST. Although it could theoretically work if both levels allowed credits for each
other’s taxes, it remains inefficient in practice.

The authors therefore conclude that the concurrent dual GST is the most suitable model for India,
provided it is carefully designed. For this system to function effectively, strong harmonization, clear
rules for inter-state transactions, and a common GST law—ideally enacted by Parliament following
the CST model—are essential.

Tax Base and Rates

Ideal Structure of GST and Tax Rate

The paper explains that an ideal GST should cover all goods and services under one broad tax base
and apply a single tax rate. This kind of system is simple and avoids confusion. However, in real
situations, governments often move away from this ideal because of concerns about how taxes
affect the poor, difficulties in administration, and political pressures. Based on studies by Poddar and
Bagchi, the paper estimates that if GST covers almost everything, the combined revenue-neutral rate
for the Centre and States would be around 11–12 percent. Using data from 2005–06, the paper
shows that the total revenue to be replaced (excluding motor fuels) was about ₹200 thousand crore.
Given a tax base of about ₹1763 thousand crore, the GST rate needed comes to roughly 11 percent.
Since central excise duties were later reduced, the Centre’s share could be around 3 percent, making
the overall rate even lower.

International Experience with GST Rates

The paper then looks at how other countries introduced GST. Successful countries started with low
rates and very few exemptions. New Zealand began with a 10 percent GST and a wide base.
Singapore started with an even lower rate of 3 percent and slowly increased it to 7 percent after
removing inefficiencies. Scandinavian countries use higher rates, but their systems are less effective
because they have multiple rates and many exemptions.

Treatment of Food under GST

Food is often taxed at lower rates or exempted to protect poor households. However, the authors
argue that this method is not effective. Rich households consume more food in absolute terms, so
they benefit more from food exemptions than poor households. A better way to help the poor is
through direct government spending. Food exemptions also create problems like disputes over
classification and loopholes in the tax system.

Land, Housing, and Real Property

The paper argues that land and real estate should be included in GST. Excluding them causes
distortions, such as higher costs for construction materials and services because tax credits cannot
be claimed. There are also frequent disputes about whether housing transactions are goods,
services, or both. Including real property in GST would simplify the system and reduce disputes.
Stamp duty cannot replace GST because it is a cascading tax charged on every transfer, unlike GST,
which taxes final consumption. If real estate is brought under GST, stamp duties should be reduced
and rationalized.

Non-Profit Sector and Public Bodies

Traditionally, many countries exempt non-profit organizations and public bodies from GST, assuming
they do not engage in commercial activities. The paper points out that this assumption is no longer
valid, as many such bodies now provide services similar to private firms. New Zealand taxes all
supplies made by governments and nonprofits and refunds taxes on their inputs. This avoids
distortions but increases administrative burden. Most countries instead exempt some activities and
allow tax credits only for taxable ones. This creates allocation problems and encourages self-supply,
where public bodies perform services themselves to avoid tax. While the New Zealand approach is
better in theory, it is harder to manage in developing countries.

Financial Services

Finally, the paper discusses financial services. All countries exempt financial services from GST
because banks and insurance companies earn through hidden charges included in interest or
premiums, which are hard to tax directly. These exemptions cause distortions, especially for
businesses that cannot claim input credits. Some countries have tried partial solutions, but overall,
exemption remains the global practice.

Treatment of Inter-State and International Trade

Taxing Cross-Border Supplies under GST

This section explains one of the most difficult parts of designing GST, which is how to tax supplies
that cross borders. These borders can be international (between countries) or inter-state (within
India). The main challenge is to decide where a good or service should be taxed.

International Trade and the Destination Principle

For international trade, the paper clearly states that GST must follow the destination principle. This
means that goods and services should be taxed in the country where they are finally consumed. So,
if something is consumed in India, it should be taxed in India, while exports should not be taxed and
should be zero-rated. The problem becomes complicated when it comes to services, because
services are intangible, mobile, and do not physically move like goods. Deciding the place where a
service is supplied is therefore difficult. The paper refers to the OECD’s 2004 guidelines and the
European Union’s rules as useful examples, but it also points out that these systems are complex and
full of classifications and exceptions. The authors stress that India needs clear and well-defined
place-of-supply rules that match international standards.

Inter-State Trade within India

Taxing inter-state trade within India is even more challenging. Normally, sub-national VAT systems
do not tax inter-state services. Under the earlier CST system, inter-state supplies were zero-rated,
but this led to revenue loss, leakages, and fraud. To solve this problem, the authors suggest a system
called Prepaid VAT (PVAT). Under PVAT, the seller in the origin State would charge GST and directly
transfer it to the destination State. This method keeps the destination principle intact and removes
the need for physical check posts at state borders.

Why PVAT is Preferred

The authors argue that border controls are not effective for goods and are completely impractical for
services. PVAT allows proper taxation of inter-state services and reduces tax evasion. The paper also
notes that when tax rates and rules are harmonized across States, there is less incentive for
businesses to misclassify transactions. Finally, the Centre can act as an audit check because the total
turnover reported under State GST should match the turnover under Central GST, helping ensure
better compliance and coordination.

Harmonization of Laws and Administration

Importance of Harmonization for GST

The paper clearly states that the success of GST depends heavily on harmonization. This means that
the laws, procedures, and administrative systems followed by the Centre and the States must be
aligned. Without harmonization, GST cannot function smoothly or efficiently across the country.

International Models of Harmonization

The authors explain how different countries handle GST or VAT harmonization. In Australia, there is
a single national GST that is administered centrally. In Canada, there is a dual system where the
central GST and the provincial Harmonized Sales Tax (HST) are closely coordinated. In the European
Union, only some parts of VAT are harmonized, while actual administration is left to individual
member States. Quebec also follows its own coordinated model within Canada.

Suggested Model for India

The paper suggests that India could follow a model similar to the Central Sales Tax (CST) system.
Under this approach, the law would be made at the central level, but the tax would be collected by
the States. According to the authors, the main aim should be to create uniformity in the tax base,
place-of-supply rules, taxpayer identification, return filing, and compliance procedures across the
country.

Role of the Centre

Finally, the authors stress that the Centre must play a strong coordinating role. While States will
continue to be involved in tax collection and administration, central coordination is necessary to
ensure consistency, reduce confusion, and make GST work as a unified national tax system.

Conclusion

The paper ends by saying that GST can become the most important tax reform since India’s
independence. It has the ability to update and improve the way taxes are managed in the country.
GST can make the tax system more transparent, reduce unnecessary complications, and encourage
people and businesses to pay taxes willingly. Experiences from countries like New Zealand and
Canada show that when GST replaces older taxes that are narrow and lead to tax-on-tax, it brings
higher revenue and better efficiency.
However, the authors stress that these benefits will come only if GST is designed properly. The
system must be fair, neutral, and well-planned. Strong political commitment, cooperation between
the Centre and the States, and careful handling of technical details are all necessary. The paper
warns that chances for such major reforms do not come often, and India should not take a slow or
half-hearted approach.

Finally, the authors point out that the decisions made while designing GST will have long-term
effects and cannot be easily changed later. If the reform is carried out with careful planning and
broad agreement among all stakeholders, GST can benefit both the government and taxpayers,
making it a true win-win reform.

Eight Years of GST

Introduction

The document reviews eight years of GST in India, calling it a transformative reform. GST is seen as a
continuous process of improvement, not a one-time change. It has improved compliance,
stakeholder confidence, and created a more certain tax environment. A key sign of maturity is the
record GST collection of INR 2.37 lakh crore in April 2025. Cooperative federalism through the GST
Council and digital reforms like e-way bills, e-invoicing, and IMS have strengthened the system.

Growth in GST Revenue and Role of Technology

GST collections have steadily grown, from INR 0.9 lakh crore in 2017–18 to INR 1.84 lakh crore in
2024–25, with April 2025 being the highest-ever collection. Growth is driven by economic activity,
enforcement, and technology. Tools like AI checks, real-time data, risk-based audits, and e-invoicing
have strengthened compliance, making GST one of the most data-driven systems globally.

Stakeholder Engagement and Policy Clarity

The government engaged with industry through circulars and policy changes, improving clarity on
issues like ISD vs cross charge, OIDAR services, corporate guarantees, and input tax credit
distribution. Section 11A of the CGST Act allows waivers for taxes unpaid due to genuine
interpretation. A GST waiver scheme encouraged voluntary disclosure, reducing litigation. Guidelines
for officers improved ease of doing business and avoided multiple investigations.

Strengthening the Dispute Resolution System

In 2024–25, the GST Appellate Tribunal (GSTAT) became almost fully operational. The tribunal will
reduce the burden on High Courts and speed up case resolution. The process will be fully digitized,
but full functionality awaits appointment of all members.

Judicial Impact and Data-Driven Administration

The judiciary has clarified GST interpretation, reducing ambiguity and fewer writ petitions. Digital
reforms like auto-populated returns, reconciliation, and IMS have minimized input tax credit fraud.
AI, machine learning, and data analytics help detect mismatches in real time, improving enforcement
and transparency.

Future Vision: GST 2.0

  The next phase aims to align GST with global trade and emerging sectors. Key reforms
include:
 Rate rationalisation: Shift from four-tier to three-tier structure to simplify compliance.
 Broadening tax base: Include petroleum products gradually, starting with ATF and natural
gas.
 Compensation cess: Remove or merge into the rate structure to reduce blockages.
 Legislative Reforms and Input Tax Credit Improvements
 Reforms are needed for long-term leases, TDR, related-party valuation, ISD vs cross charge.
Section 17(5) blocking certain input tax credits should be relaxed to make GST a true
consumption tax. Allowing ITC on construction and employee expenses will reduce business
burden.

Improving Audit and Dispute Processes

A trust-based audit system is recommended, with fewer interventions for compliant taxpayers.
Single coordinated audits for multi-state businesses, pre-adjudication mediation, anonymised
findings, and standard audit tools will smooth dispute resolution.

Technology Integration and Emerging Sectors

Greater use of AI for real-time matching, anomaly detection, and GST portal notices is encouraged.
Clear rules are needed for cryptocurrency, online gaming, AI, and electric vehicles due to rapid
innovation.

Conclusion

In eight years, GST has strengthened India’s indirect tax system through technology, transparency,
and cooperation. The next phase should focus on simpler rates, broader coverage, fewer blocked
credits, efficient dispute resolution, and digital integration. These steps will create a predictable,
globally aligned, and business-friendly GST regime for the future.

Centrally sponsored schemes

Chapter I: Introduction

The document explains how the Union Government in India transfers funds to the States, called
Central Assistance to State Plans. These transfers are of two main types: plan transfers under
schemes and block grants. Over time, plan transfers became the main way the Centre provides
money to States for development programs.

There are two main types of schemes for these transfers:

Central Sector Schemes (CS):

 Managed directly by the Union Government through its ministries.

 Mostly for areas under the Union List of the Constitution.
 fully funded by the Central Government, so the States do not pay anything.
 Projects may be implemented across different parts of the country.

Centrally Sponsored Schemes (CSS):

 Implemented by the State Governments.

 Usually cover areas in the State List or Concurrent List, like health, education, agriculture,
rural development, and social welfare.
 Funding is shared: both the Centre and States contribute money, but the Centre usually pays
more.

This explains how money flows from the Centre to the States through different types of schemes.

The introduction explains the budget for Centrally Sponsored Schemes (CSS). Until 2014–15, CSS
made up about 59% of the total Central Assistance to State Plans, making it a major way the Centre
gave development funds to States.

Over time, some issues were noticed with CSS:

 There were too many schemes, making management complex.

 The schemes were rigid, giving States limited freedom to adjust them according to local
needs.
 These problems led the government to review the CSS system.

A committee led by Shri B. K. Chaturvedi made important recommendations:

Classify schemes systematically.

Reduce the total number of schemes by merging smaller ones into umbrella programs.

These recommendations were implemented in 2013–14, resulting in:

Fewer CSS schemes.

A more organized structure, with schemes grouped by sector and intended outcomes.

These reforms started a larger process of improving the relevance, design, and efficiency of CSS.

Chapter II: Genesis of Centrally Sponsored Schemes

This chapter explains how Centrally Sponsored Schemes (CSS) started. After independence, the
Planning Commission prepared national plans and allocated funds to different sectors. The main idea
of CSS was to ensure that important national priorities were carried out uniformly across all States.

In the early years, many States lacked money or expertise to invest in key areas. Without CSS,
important programmes in education, health, agriculture, and rural development could have been
ignored. CSS allowed the Centre to lead in these sectors while still involving States in
implementation.

Over time, the number of CSS increased whenever new national priorities arose. As India’s economy
and governance became more complex, CSS became a common tool for the Centre to guide
development.

However, this growth also caused problems:

 Many schemes overlapped.

 Some were too small to make a real impact.
 Guidelines were often too rigid, so States could not adapt schemes to local needs.
 These issues led to inefficiencies and duplication of efforts in the system.

By the Eleventh Five-Year Plan, the number of Centrally Sponsored Schemes (CSS) had grown so
much that managing them became difficult. Even though the schemes were well-intentioned, the
system lacked coordination.

Many States complained that the schemes were too centralised.

The Centre argued that States did not always use the funds effectively.

This conflict showed that there was a need to rethink the purpose and design of CSS. In response,
committees and expert groups studied the system and suggested reforms. They recommended that
schemes should be better aligned with constitutional responsibilities.

Since the Constitution gives some subjects exclusively to the States, the Centre should not control
every part of schemes in those areas. Instead, the Centre should provide more flexibility to States
and focus on supporting areas of national importance.

This idea became the basis for the later restructuring of CSS.

Chapter III: Overview of Centrally Sponsored Schemes

This chapter explains the main structure and functions of Centrally Sponsored Schemes (CSS). CSS
are important for achieving national development goals. They allow the Central Government to set
priorities and provide financial support and policy guidance, while the States implement the
schemes locally and adapt them to their needs.

In terms of financing, the Centre provides the major share of funds, and the States contribute the
rest. The cost-sharing ratio depends on the type of State. Special Category States, like those in the
North-East, get a higher share from the Centre because of their geographic and economic
challenges. Other States get a slightly lower share. This system helps make development more
equitable across India.
The chapter also explains how CSS are approved and monitored. First, the ministry concerned
prepares a proposal. Then a committee appraises it, checking financial and technical aspects. After
appraisal, the competent authority approves the scheme. Once funds are released, the ministry and
States monitor progress through reports, field visits, and reviews.

The chapter highlights that one major problem with CSS was their large number—before
restructuring, there were around 147 schemes. Many had overlapping goals or were too small to
make an impact. Some required States to follow complicated procedures, slowing down
implementation. The Eleventh Plan tried to address this by rationalising schemes, but issues
persisted.

During the Twelfth Plan, the B. K. Chaturvedi committee recommended grouping CSS into umbrella
categories, merging smaller schemes with larger ones, and giving States more flexibility to adapt
schemes to local needs. This aimed to improve effectiveness and results.

The chapter emphasizes that better coordination between the Centre and States is crucial. Without
it, there is duplication of efforts, delays, and poor fund utilisation. Since CSS make up a large part of
development spending, improving their structure is vital for public expenditure efficiency.

The chapter also shows statistical trends, indicating that CSS’s share in total Central Assistance grew
significantly during the early Twelfth Plan. While CSS provided substantial funds to States, they often
requested more flexibility, shaping reforms in 2013 and 2015.

Chapter IV: Structure and Best Practices in CSS

Designing Good CSS

Centrally Sponsored Schemes (CSS) should be simple, flexible, and able to meet both national and
local needs. They must have clear goals, measurable results, and indicators to track progress.

Flexibility for States

Giving States freedom to decide what activities to carry out under a scheme helps it work better.
States are different in geography, economy, and governance, so one plan does not fit all. Some
schemes already let States choose components, allocate funds, and select target groups, which
improves results and makes States more responsible for success.

Rashtriya Krishi Vikas Yojana (RKVY)

RKVY is an example of a flexible scheme. States could plan projects based on their own agricultural
needs. A State-level committee reviewed and approved these projects. Resources were distributed
using fair, formula-based methods. Because of this, RKVY became popular. During the Eleventh Plan,
State spending on agriculture and allied sectors increased, helping build infrastructure and services.

Flexible-Fund Mechanism

The Sub-Group on CSS noted that in the 2013 CSS restructuring, at least 10% of each scheme’s
allocation had to be kept flexible. This allows States to adjust funds to local needs and makes the
schemes more effective.

Key Themes Emerging

Balancing National and State Needs

Centrally Sponsored Schemes (CSS) aim to support national development while meeting State
priorities. Over time, the schemes became complex. States felt restricted, while the Centre worried
too much flexibility could weaken national goals. Reforms were introduced to achieve a better
balance.

Reducing Fragmentation

Many CSS were small and scattered, making monitoring hard and reducing impact. Merging smaller
schemes into larger umbrella programmes helped improve focus, speed approvals, and strengthen
results.

Accountability and Monitoring

The Centre needs progress reports to ensure funds are properly used. States want simpler
procedures and less bureaucracy. Reforms aim to make monitoring easier, less intrusive, and more
focused on results.

Importance of Local Planning

RKVY shows that schemes work best when planning starts at the local level. States prepare district-
level plans, identify gaps, and propose projects based on real needs. This approach improves results
while allowing States more control.

Conclusion

Evolution of Centrally Sponsored Schemes (CSS)

The document explains how CSS developed and became a key tool in India’s development strategy.
Over time, the schemes created challenges due to their number, complexity, and centralised design.

Need for Restructuring and Flexibility

The text highlights that India’s diversity requires schemes that are nationally guided but locally
adapted. Reforms focused on making CSS simpler, flexible, and better coordinated between the
Centre and States.

Structure and Monitoring

It describes Central Sector Schemes, CSS, cost-sharing rules, approval processes, and monitoring
systems. These mechanisms were designed to ensure funds are used effectively and schemes
achieve their objectives.

Successful Models: RKVY

The Rashtriya Krishi Vikas Yojana (RKVY) is presented as a successful example. It empowered States
to plan and implement schemes according to local agricultural needs while maintaining
accountability and fair resource allocation.