Significant economic contraction and GST compensation

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By: Ramesh Kanitkar

The economic slowdown aggravated by the onset of the COVID-19 pandemic and prolonged lockdowns had led to a significant contraction of the Indian economy, adversely affecting growth and revenue projections, including the goods and services tax (GST) collections. The issue of the payment of GST compensation, which is due to the states, had become contentious since August 2019. This was because of the recurring delays in compensation payments to states, flouting the stipulated norm that such compensation should be provisionally calculated and paid every two months. The states are legally entitled to the compensation for the revenue loss occurring due to the implementation of the GST for a period of five years (2017–22), as per the GST (Compensation to States) Act, 2017, from the GST Compensation Fund.

As the states had ceded their powers to levy indirect taxes that were subsumed under the GST to the centre, the former are legally entitled to the shortfalls in revenue caused by the transition to the new GST regime. The shortfall in revenue has been calculated by projecting a revenue based on 14 per cent compounded growth from the base year’s (2015–16) revenue and computing the difference between that figure and the actual GST collections in that year. With the ensuing recession, at the end of the current financial year, the GST Compensation Fund is projected to face a shortfall of about Rs.2.35 lakh crore. This is because the compensation fund is expected to accrue a cess and balance of only Rs.65,000 crore, while the shortfall in revenue is estimated at Rs.3 lakh crore. The agenda in the meeting of the GST council on 27 August 2020 was to find a possible way to ensure that the compensation entitled to states would continue to be paid.

However, the outcome was unexpected. The centre not only reneged on its promise to states to meet the shortfall in compensation, but also insisted that, of the projected shortfall of about Rs.2.35 lakh crore, onlyRs.97,000 crore was due to the implementation of GST. The rest of the amount, that is, Rs. 1.38 lakh crore was attributed to the COVID-19 pandemic, which according to the finance minister and chairperson of the GST Council, was an “act of God,” a crisis independent of implementation of the GST. Based on this rather faulty premise, the centre proposed two options for the states to consider in order to bridge the shortfall in revenue. The first option was a special window to the states, in consultation with the Reserve Bank of India (RBI), to borrow the projected GST shortfall of Rs.97,000 crore. For purposes of its overall debt calculation, this additional borrowing would not be accounted for as a part of the state’s debt and the repayment of the principal and interest on these borrowings would be made from the compensation fund by extending the period of cess collections beyond 2022.

Further, delinked from the conditions linked to the implementation of reform measures, a 0.5 per cent relaxation in the borrowing limit under the Fiscal Responsibility and Budget Management (FRBM) Act would be provided. Under the second option, the states could borrow from the market to raise the entire Rs.2.35 lakh crore shortfalls, but the interest cost would have to be borne by states, and only the principal would be serviced by the compensation fund. But the non-BJP-ruled states, particularly Kerala, Punjab, West Bengal, Delhi, and Chhattisgarh have rejected both options and made it clear that the onus is on the centre to borrow from the market and provide compensation to states. This suggestion is based on the premise that imposing these options upon the states, while also bringing about a distinction between GST and pandemic-related revenue loss was unconstitutional. Section 18 of the Constitution (One Hundred and First Amendment) Act states that Parliament, on the recommendation of the GST Council, shall provide for compensation to states for the loss of revenue arising out of implementation of the GST for five years.

Moreover, the states are entitled to the guaranteed compensation irrespective of the collections under the cess. Then, why should the states undertake an additional debt burden on themselves in lieu of the compensation payment that they are entitled to legally? The centre has both a moral as well as a legal obligation towards the states and it could borrow and mobilise resources in order to bridge the gap in the GST cess and provide compensation to states. This sounds like a reasonable expectation on the grounds that as compared to the states the centre has more powers and resources. For, the centre has access to more buoyant sources of revenue like income tax, corporation tax, and customs duties which are outside the ambit of GST. Besides, the centre has access to more non-tax revenues such as dividends from the RBI and central public sector units. Further, the states which are constrained by stringent limits on borrowing have disproportionately borne the burden of fighting the pandemic. In the ever enlarging health and economic crisis, instead of reneging on its promise to states, and aggravating their fiscal maladies, the centre should borrow to compensate the states for the revenue shortfall. Thereby, the centre could fulfil its constitutional obligations enshrined in the 2017 act without subjecting the state governments to any additional strain, thus, upholding the spirit of cooperative federalism. INAV


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