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GST Compensation Bickering

The GST compensation to the states has been the headline for mainstream media nowadays. I shall take you back in 2016-17. The central government was trying to make consensus but States were hesitating to join a new tax regime. They were of the opinion that new tax law will bring revenue loss for them. The Standing committee on Finance in its 73rd report recommended that a well-defined automatic compensation mechanism should be incorporated. Subsequently, the Select Committee in its report also recommended that the revenue loss to the states should be compensated for a period of five years.

States joined GST only when a provision was made in bill for the same. The section 18 of the constitution (101 amendment) act, 2016 says “Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of of the goods and services tax for a period of five years” from July 1, 2017. Accordingly, GST (Compensation to State) Act, 2017 was passed. The section 7 of the act says the loss of revenue will be compensated at the end of every two months for five years.

Now, the Centre is not honouring its commitment. FM Nirmala Sitharaman said that the economy is facing an extraordinary ‘Act of God’ situation. Earlier, she spoke to Parliament that the government would transfer compensation only from the amount collected through the cess. No doubt it is a difficult time, but the economy was in perils even much before Covid-19. The GDP growth rate for FY20 has reached 4.2% – the lowest in the decade. Now, it has shrinked to 23.9% in Q1 for FY21

The government is quoting its discussion with the Attorney General that says the compensation gap can not be bridged using the Consolidated Fund of India. It can be done only through the Compensation Cess Fund and the compensation leavy can be extended beyond five years to meet the shortfall.

The 41st meeting of the GST Council was held on August 27 to discuss – how to pay compensation to the states. The government has estimated the total shortfall for states would be ₹3.0 lakh crore and the compensation cess collection of ₹ 65000 crore for FY21. Therefore, the gap will be ₹2.35 lakh crore. The gap bifurcated into two parts. First, the gap due to introduction of GST is estimated to be ₹ 97000 crore only. Second, the rest is owing to the pandemic effects.

The government has given two options to the states to compensate them. First is an offer of a special window in consultation with the RBI to collect ₹ 97000 crore. Second, an option to borrow the entire gap of ₹ 2.35 lakh crore from the market, facilitated by the RBI. The repayment of principal and interest on the borrowed money would not be met by the collection of cess.

The shortfall is calculated assuming a 14% annual growth in GST revenue over the base year of 2015-16.  However, the rating agency – ICRA has estimated that the total SGST collection will decline by 21% to ₹ 4.01 lakh crore in FY21 against ₹ 5.06 crore in FY20. The total amount required for compensation this year could be ₹3.63 crore.

The government had targeted ₹1.09 lakh crore to collect through cess for FY20. The target was further revised downwards to ₹ 98327 crore. However, the actual collection of cess was ₹95444 crore and the total amount of compensation issued was ₹ 1.65 lakh crore. It was 73% more than the total cess collection. The deficit amount of ₹ 69858 crore was arranged by the balance cess amount collected during FY18 and FY19.

In addition to this, the government had also transferred ₹ 33412 crore from Consolidated Fund to the Compensation Fund as the cess collections were inadequate to compensate states. The central government has issued GST compensation of ₹ 41146 crore to states against the collection of cess of ₹ 62596 crore for FY18 and ₹ 69275 crore against the collection of ₹ 95081 crore for FY19.

The officials of the Finance Ministry briefed before the Parliamentary Standing Committee on Finance on July 28,  that the government is not in the position to pay the GST compensation to states. The Finance Secretary conveyed the chairman of the committee that the GST Act has a provision to rework the formula for paying compensation.

The central government has not paid the compensation amount of ₹1.5 lakh crore for the first four months of FY21 to states. The actual delays started last year – when payment due for August-September was paid on December 17, 2019. Since then, all upcoming payments have been delayed. The payment of October-November was paid in two instalments – February 21 and April 8 2020. Further, the amount of December-February was paid on June 4 and the payment of March was on July 27, 2020.

States had already raised their concerns about the delayed payment of compensation. West Bengal FM has urged the central government to honour the commitment to pay compensation. Some of the non-BJP ruled states showed their dissatisfaction at the solution given by the centre. They are thinking that the decision has been imposed on them. Earlier, the decisions of the GST Council used to be based on consensus but now it is a majoritarian decision. However, BJP ruled states welcoming the step as it will not increase the burden on the exchequer.

Shall states be asked to borrow from the open market/RBI. It is an act of shifting the debt onto the balance sheet of states. It will increase the Debt-GDP ratio and that will affect the financial health of the states. It is pushing states to find new sources of revenue.  It is the responsibility of the centre to borrow the money to bridge the revenue gap.

About Author: Vinay K. Srivastava




(Vinay K. Srivastava teaches Finance at ITS Ghaziabad. He recently published his next co-authored book – ‘Indirect Tax Reform in India: 1947 to GST and Beyond’. He may be reached at twitter @meetdrvinay)

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