The goods and services tax (GST), one of Prime Minister Narendra Modi's major reforms, if not his biggest, has run into trouble on the back of the coronavirus pandemic and a contracting economy.
The GST, which cut down a web of taxes at the federal and state levels, was a massive political victory for Mr Modi who, due to his government's majority, pulled off a reform in 2017. Previous governments had tried and failed to do so because of a lack of political consensus.
Now, the tax, dependent on cooperation between states and the federal government, has been hurt by the coronavirus pandemic and low GST collections, resulting in a revenue shortfall of 2.35 trillion rupees (S$43.7 billion).
Finance Minister Nirmala Sitharaman announced late last month that the federal government would be unable to compensate the states.
Instead, she asked the states to borrow the amount from the Reserve Bank of India, among other options.
Compensating the states was the foundation on which the GST was negotiated because it got doubting states to agree to a revenue-sharing model to make up for losing state taxes like Value Added Tax.
The result has been strong opposition from at least five opposition-ruled states that have accused the federal government of going against the spirit of federalism and reneging on the compensation deal.
The West Bengal government has called the move a "planned strategy to crush federalism" while the Delhi government called it the "biggest betrayal" in the history of federalism in India.
Kerala Chief Minister Pinarayi Vijayan in a letter to Mr Modi noted that no compensation had been released to the states since April 1, when the deal was for the federal government to transfer compensation every two months.
"It is felt that transferring the obligation of GST compensation to the states through their borrowing is not in accordance with the spirit of understanding reached between the Centre & the States," he wrote in the letter.
Under the GST Act, states were guaranteed full compensation for any revenue loss in the first five years.
This compensation was to come out of a cess on sin and luxury products, such as liquor and cigarettes.
About India's GST
• India introduced the goods and services tax in 2017.
• Unlike Singapore, India does not have one tax slab for all goods and services but four different slabs, ranging from 5 per cent to 28 per cent.
• The government faces a revenue shortfall of 2.35 trillion rupees (S$43.7 billion).
• Kerala, Punjab, West Bengal, Puducherry and Delhi are against the proposal that they borrow from the Reserve Bank of India.
India had one of the most stringent lockdowns, shutting down all economic activity when there were a few hundred Covid-19 cases in March.
Since April, the government has been slowly easing restrictions to spur economic growth, which has remained sluggish amid rising coronavirus numbers.
Latest figures show India has over 4.5 million cases, and the economy contracted by 23.9 per cent in the April to June period.
Making up the shortfall would not be easy given the state of the economy, said analysts.
"The problem has become aggravated due to a steep fall in collection due to Covid-19 and impact on the compensation pool with cess on luxury goods coming down. Sales of luxury cars, for example, have come down," said Mr Muralidharan Ramaratnam, a senior director specialising in indirect taxes at Deloitte India.
The GST council, which controls GST and has federal and state representatives, is set to meet on Sept 19. Indian media reports said the federal government is working on solutions, including paying part of the compensation.
There is little good news on the collection front. August revenues slipped around 1 per cent from the previous month to 864.49 billion rupees. Many businesses have seen falling or no revenues.
"This is an ongoing problem for the (federal government) as the economy is unlikely to recover soon given the staggered opening of the economy, the pandemic moving to rural areas and increased numbers (of cases)," said Mr Rishi Sahai, managing director and co-founder of corporate finance firm Cogence Advisors.
Some states have suggested tax slabs or cess rates be raised to bolster revenues. This means bringing more items to the 28 per cent slab.
They have also suggested that the federal government borrow and compensate the states.
"Ultimately the whole thing comes down on us (the taxpayers). But the states are tense; if they put a load on citizens, it will put a negative effect on the vote bank. West Bengal is going to the polls soon," said Kolkata-based economist Professor Sarthak Roychowdhury.