ECONOMY: THE GST MUDDLE
Three years after India began implementing a bold new, if still undercooked, Goods and Services Tax (GST) regime on July 1, 2017, a hard-won agreement between the Centre and states on the terms of transition is being severely tested. The latest sore disagreement is over the Centre’s decision to withhold the promised compensation to states for shortfalls in their tax revenues as a result of implementing GST.
GST collections were hit hard as the economy ground to a nearstandstill during the lockdown, and after dragging its feet for a while, the Centre broke the bad news to the states in the GST council meeting on August 27. Union finance minister Nirmala Sitharaman announced that the Centre would perforce have to withhold the promised compensation. Many were bracing for this when Sitharaman served notice in that same meeting with her statement that the Covid-19 pandemic was an ‘act of god’.
To tide over the crisis and as an alternative way of compensating for their revenue shortfalls, the states, Sitharaman said at the GST council meeting, would have two options: borrow up to Rs 97,000 crore, the projected shortfall arising from the implementation of GST, in a special window facilitated by the RBI, or borrow the entire Rs 2.35 lakh crore, the total projected loss for the financial year, from the debt market. The compensation amount for 2020-21 is estimated at Rs 3 lakh crore, of which only Rs 65,000 crore will be paid out of the cess levied by the Centre. On the remaining Rs 2.35 lakh crore, the Centre has granted itself an ‘act of God’ waiver!
The baldness of this statement has obviously riled states no end, who are desperately short of revenues to fund both capital expenses and welfare initiatives—and have no additional tax levers. (Apart from stamp duty, the only two GST-exempt sources of tax revenues for states are petroleum and alcohol.) In fact, the consensus to give up the myriad indirect taxes was won with the promise to compensate states for their revenue shortfall.
The shortfall was to be assessed, assuming a 14 per cent growth rate in GST revenues. The 14 per cent growth rate was, in turn, based on assumptions of GST buoyancy and nominal GDP growth. However, it has been three years since GST was implemented and tax collections have been anything but buoyant. The GST cess, which was to finance the compensation payment to states, was failing to garner enough funds even before the pandemic struck.
The economic slowdown, which had already set in before the pandemic, has naturally impacted tax revenues as well. Indirect taxes—consisting of Union excise duty, service tax, customs duty, central GST, Union territory GST, integrated GST and GST compensation cess—showed a sharp contraction of 52.5 per cent during the April-June quarter of FY2020-21, compared with a 4 per cent contraction in the corresponding first quarter of FY2019-20.
Payment delays in GST compensation started nearly a year ago—when compensation was delayed for AugustSeptember 2019. The Centre first admitted to a problem at the 37th GST council meeting held in Goa last September. On November 27, 2019, it wrote to the states that the GST and compensation cess collections in the previous few months had become “a matter of concern” and that compensation requirements were “unlikely to be
`3 LAKH CRORE The GST compensation amount for FY20-21
52.5% The contraction in indirect taxes during the first quarter of FY20-21
met”. The compensation payment of Rs 35,298 crore for August-September 2019, due in October, was paid in December; and payments for October and November 2019 were released in February and April 2020.
Thirteen BJP-ruled states have quietly fallen in line with the Centre’s fallback plan, and submitted their borrowing choices. Twelve have opted for the first option; only Meghalaya has said it will borrow from the market. Non-BJP states, however, are up in arms against what they say is a violation of the spirit of the agreement that formed the basis of implementing GST.
West Bengal, Telangana, Kerala, Delhi, Chhattisgarh and Tamil Nadu have written to the Centre, opposing the proposal that states borrow to meet their shortfall. Kerala has said enforcing a cut in compensation and making a distinction between GST and Covid-related loss of revenue is unconstitutional. It has also argued that the FRBM (Fiscal Responsibility and Budget Management) limit on the fiscal deficit of states should be raised by at least 1.5 percentage points if Rs 2.35 lakh crore is to be borrowed from the market. Delhi has raised concerns that the national capital’s status of a Union territory could hurt its ability to borrow via the RBI (in the first option). West Bengal has argued that any other interpretation of the compensation related Section 18 of the Constitution Act 2016—which ushered in GST—is indefensible (Sec. 18 of the Act says Parliament on the recommendation of the GST council will provide compensation to states for the loss of revenue arising from implementation of GST for five years).
Under the first option, the amount can be repaid after five years of GST, ending June 2022; there is also a 0.5 per cent relaxation in the borrowing limit under the FRBM Act. No FRBM relaxation has been announced so far under the second option of borrowing from the market.
Economists caution that the Centre’s high-handedness in trying to discipline states while not keeping its own end of the GST bargain could further hurt India’s economic recovery. Many of them argue that the Centre is in a far better position to mobilise funds than the states. “This is no time to discipline the states,” says an economist, requesting anonymity. “States will be forced to cut back capital expenditure and end up borrowing at higher interest rates.”
Revenues from taxes account for about 45 per cent of the total revenues of states, and according to an RBI study of state finances, central transfers account for 47.5 per cent of their revenues. Nearly 90 per cent of the tax revenues of states come from taxes on liquor, petroleum products, stamp duty and registration of vehicles. However, the slowdown has hit collections under all these tax heads. With state finances in such a perilous state, “making them borrow rather than giving them money will make their situation even more critical”, said the economist quoted above. The Centre might like to reconsider its options.
KERALA HAS ARGUED THAT THE FRBM LIMIT ON THE FISCAL DEFICIT OF STATES SHOULD BE RAISED BY AT LEAST 1.5 PERCENTAGE POINTS