Grim Sovereign Tangle: On GST compensation standoff

Context

• Three years after the introduction of India’s new indirect tax regime, GST, it has started to face an existential crisis. The gains of GST have started to quickly erode as the slowdown in the economy, exacerbated by the Covid-19 lockdowns, has thrown all revenue calculations to the wind.
• Due to huge shortfalls in the tax collection under GST the Central government and State Government has come at loggerheads as Centre has shown its incapability to compensate the States as promised under the GST Act 2017.

GST Compensation to the states:

• After the introduction of GST States have very limited taxation rights as most of the taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under GST.
• GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.
• Under the GST (Compensation to States) Act, 2017, states are guaranteed compensation for loss of revenue on account of implementation of GST for a transition period of five years between 2017 and 22.
• The compensation is calculated based on the difference between the states’ current GST revenue and the protected revenue after estimating an annualised 14% growth rate from the base year of 2015-16.

Why states have to be compensated?

• In theory the GST should generate as much revenue as the previous tax regime.
• However, the new tax regime is taxed on consumption and not manufacturing.
• This means that tax won’t be levied at the place of production which also means manufacturing states would lose out and hence several states strongly opposed the idea of GST.
• It was to assuage these states that the idea of compensation was mooted.
• To make this promise watertight, the idea of compensation was both written into the Constitution and its finer details passed by way of central legislation.

Issues:

• The Union Finance Minister in a recently held 41st GST Council meeting asserted that the Centre will not be able to compensate the States.
• The Central Government is asserting that GST collections have sharply come down this year due to the Covid-19 pandemic.
• The GST compensation requirement is estimated to be around Rs 3 lakh crore this year, while the cess collection is expected to be around Rs 65,000 crore. Thus there is an estimated compensation shortfall of Rs 2.35 lakh crore.

Centre’s Recommendation:

• States have been given two options to remedy the situation and both require them to borrow from the market.
• The Centre contends that only ?97,000 crore of the revenue shortfall is from implementation of the GST, while ?1.38-lakh crore is due to extraordinary circumstances posed by an ‘Act of God’ (Covid-19)
• States can either borrow ?97,000 crore, without having it added to their debt and with the principal and interest paid out from future cess collections, or they can borrow the entire ?2.35-lakh crore shortfall, but will have to provide for interest payments themselves.
• The Finance Ministry has argued that higher borrowing by the Centre will push up interest rates and dent India’s fiscal parameters.

State concerns:

• Five states and Union Territories of Kerala, Punjab, West Bengal, Puducherry and Delhi have voiced their concerns over the proposals.
• They are stating that the Finances of the states are under severe strain, resulting in delays in salary payments and sharp cuts in capital expenditure outlays due to the pandemic and lockdowns.
• They are also battling the Virus and hence they need to spend on their healthcare too.
• In light of these circumstances several states have rejected both the options and have urged the Centre to rethink.
• They say that while the Centre chose to pin much of the blame for the delays on GST compensation payments on the pandemic it started before the pandemic.
• The payments due for August-September 2019 was delayed and since then, all subsequent payouts have seen cascading delays.
• In Fact the Centre had admitted to problems on compensation payment in the 37th GST Council meeting held in Goa in September 2019 itself.

Way Forward

• It is time for states to accept the realities and agree to a lower level of compensation, ideally linked to the growth rate of the Indian economy in nominal terms.
• The Union government must also need to lead the country out of its GST impasse by borrowing more from financial markets or directly from RBI.
• States should reciprocate by settling for a more realistic compensation for time being while exploring the options suggested by the Centre.