The introduction of the 122nd Constitution Amendment Bill in Parliament’s winter session to clear the way for the Goods and Services Tax (GST) is great news. Even though the intent to create a common market by eliminating tax barriers on inter-state sales was marred somewhat by the temporary retention of a reduced barrier, that is a small price to pay for the passage of such a landmark bill. The tax on inter-state sales is to be levied and collected by the Centre but with the revenue handed over to the selling state. Named an additional inter-state levy, it is essentially a replacement for the Central Sales Tax (CST), albeit at 1%, lower than the present 2% CST. It will be in place for two years, but is extendable by the GST council, and could in principle be around for some years into the future. This and the compensation provision for revenue losses right in the constitutional amendment itself are seen by many as deep flaws in the bill. Compensation carries a sunset clause of five years, and was possibly the only way states could have been brought on board for such a major reform. The continued inter-state levy is essentially an adjunct to this provision, since the compensation payable will be reduced by the amount collected through the additional levy. Defenders of the need to insert compensation into the constitutional amendment see a need for statutory comfort to states, given the past history of broken compensation promises by the Centre, when CST was halved to 2%. The sunset clause, however, makes it tolerable, and is an implicit recognition that there will be an eventual revenue gain from GST to all parties, by virtue of the efficiency and compliance properties of the new levy. It also incentivizes states to eliminate CST while still within the compensation period. Looking past its flaws, the bill carries two commendable features. The first is the long list of taxes that have been withdrawn. Among them is the purchase tax, legally leviable by any state on purchases within its boundaries but whose incidence, in the case of bulk purchase for nationwide sale, falls on buyers outside the state. The Punjab purchase tax on foodgrains has been paid regularly as part of the procurement price by the Food Corporation of India. Likewise, the Assam purchase tax on crude oil has been incorporated into the price at which oil refinery products from that state have been bought by the oil marketing companies. Purchase taxes on food and oil have ramped up the food and petroleum subsidies over the years. In both cases, the new additional levy of 1% will reduce the burden on the food and petroleum subsidies. At the same time, of course, the revenue compensation ensures that over a period of five years, a compensation burden will continue on the central exchequer in place of the subsidy burden. The second commendable feature of the bill is that contentious issues surrounding rate structure, thresholds for taxability, and exempted goods, have been assigned to the GST council, an inter-state body, whose formation and operating procedures have been clearly spelled out. It was extremely important to keep these issues outside the scope of the constitutional amendment bill, so that any change in operating parameters did not have to require further amendments to the Constitution. On balance, therefore, the amendment is an excellent beginning. The state GST will not be levied on exports from one state to other states, but the central GST will (since to the Centre, an export happens only when the good or service goes to other countries). The revenue from the central GST on inter-state sales is to be apportioned between states in a manner to be decided by the GST council. This particular feature is regrettable, because it requires a carve-out from the total revenue collected by the Centre from GST. Calculational complexities of this kind are best avoided. The carve-out is unnecessary in view of the transitional compensation scheme, and could still be deleted before final passage of the constitutional amendment. Without that, there remains room for the eventual possibility of the Centre demarcating a portion of its overall GST collection for shoring up the revenues of municipalities, which are in terrible fiscal shape. The battle lines between producer and consumer states over GST, and earlier over the state value added tax (VAT) when it was introduced, result from an original sin—CST. The right given to states to tax sales, in List II of the seventh schedule of the Constitution, did not permit taxation of sales across state borders. States which, for locational or historical reasons, had industrial belts and despatched goods across the country demanded revenue compensation for the services they provided to enable production within their boundaries. In those days of administered prices, the claim was undoubtedly backed by underpriced inputs. To this day, states like Punjab levy a purchase tax on foodgrains instead of reducing the subsidies on inputs to agriculture like water and electricity. CST was, therefore, seen as a neat solution by which to levy a tax on inter-state sales, by naming it central, but allowing states to collect and retain the revenue proceeds. It continued at (a maximum of) 4 % for so many decades that collecting states regarded it as a permanent revenue entitlement. At no point were states with CST revenue made to see that as production centres, they were already reaping the revenue advantage of high consumption from incomes earned by residents within their states. The present tax reform, which marks the culmination of what was begun with the state VAT on goods, rams home exactly that message. Exporting states reap revenues from the high consumption of the producers located within their boundaries. Meanwhile, the 4% CST, which functioned essentially as an export tax, and therefore as a self-inflicted competitive disadvantage, did not actually result in importing states building up their own production centres behind this externally provided protection barrier. The cost disadvantage in most other states was simply too high to compensate for a tax barrier at a mere 4%. In recent years, however, increasing congestion has finally robbed first movers of their historical advantage, and there has been some spatial dispersal of activity, especially in production of intermediates after the introduction of the state VAT starting 2005. This activity is what has led to the new buzz in small town India. When states agreed to come down in stages from a 4% CST with imposition of the state VAT on goods starting 2005, they were promised compensation, which was variously not delivered. Thus began the mistrust of the Centre by states, which has to be very carefully bridged today. Even so, the process of reducing CST today has many takers. Even first movers are able to see the cost advantage to producers within their boundaries of sourcing intermediates from outside the state at lower rates of CST levy, and that perceived advantage has to be built up slowly but surely to wean these states off CST altogether. The amendment bill is just a beginning. The GST council has to be constituted with membership as prescribed in the bill, and the vexed issue of the rate structure has to be resolved. Present-day central levies on services and goods cascade onto the state VAT, resulting in tax rates in the 28.20-30.80% band (cascading makes the final incidence more than the simple sum of rates). Existing suggestions for GST rates going up to 27% approach the current levels of taxation prevailing. That will make GST not a reform, but just a slightly cleaned-up replacement. The search for revenue neutrality at present rates of levy is being done in a static way, not factoring in two improvements GST is meant to bring in. There is first the compliance improvement expected, as a result of sellers being keen to collect from their buyers the tax from which they can claim a refund on taxes they paid on inputs. This revenue chain acts as an inducement to enter into the tax net. Then there is the growth impact of the levy. Even if expectations that GST will raise the growth rate by anywhere from 1-2 percentage points sound implausible, every reduction of the levy on inter-state sales clearly enhances the ability to source low-cost inputs (including services) from across state borders. The cost reduction and efficiency enhancement possibilities are immense. At a time when the Indian economy is suffering from depressed growth and elevated prices, GST is a reform we cannot afford to lose through poor management of transition problems. The staggered march through first initiating moves towards a VAT configuration by the Centre and states within their independent taxation spheres has given enough time for all parties to see the advantage to themselves of moving forward, together. Indira Rajaraman is an economist and is currently on the board of directors of the Reserve Bank of India.