What is the GST compensation due to States?
Context: The 41st meeting of the GST Council was held on August 27 with the singular agenda of finding a solution to the question of how best to ensure that the compensation payable to the States as part of the implementation of the Goods and Services Tax continues to be paid.
- The background for the meeting was the fact that the Centre and the States were cognisant of the substantial impact on GST collections from the last fiscal year’s economic slowdown and more recently the lockdowns and COVID-19-related curbs that have severely shrunk the economy.
- At the meeting, Finance Minister Nirmala Sitharaman stated that the GST Compensation Fund was projected to face a shortfall of about ₹2.35 lakh crore at the end of the current financial year and suggested two borrowing options that the States could choose from to bridge the shortfall.
What is the GST compensation?
- The Constitution (One Hundred and First Amendment) Act, 2016, was the law which created the mechanism for levying a nationwide GST.
- Written into this law was a provision to compensate the States for loss of revenue arising out of implementation of the GST. The adoption of the GST was made possible by the States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed under the GST.
- While the States would receive the SGST (State GST) component of the GST, and a share of the IGST (Integrated GST), it was agreed that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in 2022.
- This corpus, in turn, is funded through a compensation cess that is levied on so-called ‘demerit’ goods. The computation of the shortfall — the mechanism for which is spelt out in Section 7 of the GST (Compensation to States) Act, 2017 — is done annually by projecting a revenue assumption based on 14% compounded growth from the base year’s (2015-2016) revenue and calculating the difference between that figure and the actual GST collections in that year.
- For the 2020-21 fiscal year, the revenue shortfall has been anticipated at ₹3 lakh crore, with the Compensation Fund expected to have only about ₹65,000 crores through cess accruals and balance to pay the compensation to the States.
How are the borrowing options supposed to work?
- Asserting that it is under no obligation to make good any shortfall in the GST and that it is up to the GST Council to devise a solution, the Union government has proposed that the States borrow directly from the market by issuing debt under a special window coordinated by the Ministry of Finance.
- The Centre has also contended that of the projected shortfall of about ₹2.35 lakh crore, only ₹97,000 crore is the deficit arising out of GST implementation, with the balance ₹1.38 lakh crore attributable to an ‘act of God’ (the COVID-19 pandemic) that is independent of the implementation of the new indirect tax regime.
- Accordingly, Option 1 entails the States selling debt securities in the market to raise the ₹97,000 crores. The Centre will “endeavour” to keep the interest cost on these borrowings “at or close to” the yield on G-Sec (bonds issued by the Government of India), and in the event of the cost being higher, bear a part of the difference through a subsidy.
- This additional borrowing by the States will not be accounted for as a part of the State’s debt for purposes of its overall debt calculation, and the repayment of the principal and interest on these borrowings will be done from the Compensation Fund by extending the period of cess collections beyond 2022.
- Under Option 2, the States can sell debt in the market to raise the entire ₹2.35 lakh crore shortfall but with the terms of the borrowing being far less favourable. Crucially, here the interest cost would have to be borne by them with only the principal being serviced by the Compensation Fund.
Why is there an impasse on this issue?
- The several States, including West Bengal, Kerala, Punjab and Tamil Nadu, have rejected the options and made clear that the onus is on the Centre to borrow from the market to make good any shortfall in the Compensation Fund.
- Tamil Nadu, in a letter to the Prime Minister, stressed that the States had agreed to the implementation of the GST only on the basis of the “unequivocal commitment given by the Government of India to compensate the States for any revenue loss”.
- Observing that States had not only suffered severe losses in revenue in the wake of the pandemic but had also been at the forefront of the battle to prevent the spread of the disease, Tamil Nadu said any delay in ensuring the compensation payments would compromise essential capital spending by the States to restart the economy effectively.
- These States dismiss the Centre’s contention that any additional borrowing by it would have deleterious macro-economic consequences and point out that global credit rating agencies essentially monitor the overall general government deficit and borrowing levels.