GST compensation: What the Centre and states disagree on

The Goods and Services Tax (GST) compensation to the states has been in the news lately, with most people confused about what the issue is, what the amounts in question are, how they are calculated, and what the Centre’s duty is. Here’s a quick breakdown of the relevant details.

What is GST compensation?

One of the main reasons the states agreed to get on board with a nationwide GST was because the Centre promised to fully compensate them for any losses that might arise from the implementation of GST for the first five years.

This compensation is to be paid from a Compensation Fund. This fund is replenished through a cess that is levied on items in the 28 per cent GST slab. The GST Compensation Act specifies how the compensation amount is to be calculated. The assumption is that the states would see a 14 per cent increase in revenues regardless of GST, and so, if for the first five years they do not see this increase, the Centre would compensate them the difference.

This system has so far been successful, with the Centre being able to pay full compensation for the first three years of GST.

What is the issue?

The current financial year is far from normal. Covid-19, the lockdown, and the subsequent limp towards normalcy will mean GST revenues and cess collections will both be far below normal. The finance secretary has already informed a Parliamentary Standing Committee that cess collections will not be enough to pay the compensation.

The issue has been discussed before, as shown by the minutes of the fifth, seventh and eighth GST Council meetings. It was agreed during these meetings that a shortfall in the Compensation Fund would not be met from the Consolidated Fund of India. It was also decided that the GST Council would take a call as to what to do when such a situation arose.

That situation has now arisen and so, during the 41st meeting of the GST Council on August 27, GST compensation was the sole agenda item.

What is the Centre’s argument?

The Centre argues that the GST Compensation Act is a legislation “to provide for compensation to the States for the loss of revenue arising on account of implementation of the goods and services tax”. The burden of compensating losses arising due to Covid-19 or any other reason that don’t have to do with GST implementation, therefore, is not the Centre’s responsibility, it argues.

Therefore, during the August 27 meeting, the Centre gave states two options. Under the first, states could borrow ~97,000 crore (which the Centre says is their loss in revenue attributable to GST implementation) from the Reserve Bank of India (RBI) at a concessional rate to be negotiated by the Centre. In this option, the increased borrowing by the states would be over and above any other borrowing ceilings. Further, the principal and interest would be paid using the compensation cess, so there would be no added burden on the states.

The second option is for the states to borrow the entire loss amount (attributable to GST, Covid-19 and any other factor) of ~2,35,000 crore from the RBI. However, this borrowing would be included in the borrowing ceilings set for the states, which would crimp their borrowing ability for other uses. Further, the states would have to pay the interest from their own finances. The compensation cess would only pay the principal of the loan.

The states were given a week to decide which option they preferred.

What is the states’ view?

The states argue that they gave up a lot of their previous autonomy over revenue generation when they signed on to GST. They would have been able to mitigate the Covid-19 impact using other revenue-generating measures if they had not committed to GST, they say. Therefore, they say the Centre should compensate them for the full loss amount and it should be the Centre that borrows the funds needed.

What next?

According to reports, 10 states are set to reject the two borrowing options provided by the Centre. The first, they say, is too little to compensate them and the second involves the states paying the interest on the loan, which is an unfair burden.

The GST Council can, for the first time ever, take the issue to a vote. The states together account for two-thirds of the vote, and the Centre for one-third.