Can Centre default on GST compensation to states?

August 20, 2020 5:15 AM

The centre must dip into the consolidated fund to pay the states the compensation amount due to them. It may not have a legal obligation, but it does have a moral one.

The states’ anxiety is compounded by the finance minister’s statement in her budget speech that, starting this year, compensation payments to states will be limited to collections under the cess.

By GR Reddy

States are agitated about the undue delay by the Centre in paying them the GST compensation, especially as they are starved of funding for fighting the Covid-19 pandemic. As per the GST Compensation Act, the Centre is mandated to compensate the states for loss of revenue on account of implementation of the GST for a period of five years. The compensation payments are to be funded by the Centre levying a cess on the GST on specified goods.

In the first two years after the introduction of GST in 2017, the scheme worked smoothly as collections under the cess far exceeded the compensation demand. In fact, the Compensation Fund built up a surplus of about Rs 47,000 crore in these two years.

A problem arose last fiscal (FY20) when the cess collections fell short of the compensation demand by as much as R70,000 crore. The Centre did eventually pay the full compensation, but after long delays, in contravention of the stipulation in the Act that the compensation should be provisionally calculated and paid every two months. While the dues for the months of December 2019 and January 2020 were paid in June 2020, those for February and March 2020 were paid in July. The Centre met the shortfall in the cess collection by using up the surplus in the compensation fund and, then by dipping into the IGST balance parked in its consolidated fund.

For the current year (FY21), states have not been paid any compensation so far. The states’ anxiety is compounded by the finance minister’s statement in her budget speech that, starting this year, compensation payments to states will be limited to collections under the cess. States, on the other hand, believe that they are entitled to the formula-based compensation regardless of the collections under the cess.

Unsurprisingly, the funding problem has become more acute this year. Rough estimates point to states’ collections under the GST during the first quarter of this fiscal being lower by at least 40% as compared to the collections during the corresponding quarter of the last year. On the other hand, as per figures put out by the Controller General of Accounts, GST cess collections were Rs 14,482 crore in the first quarter of the current fiscal, compared to Rs 24,613 crore in the corresponding quarter of last fiscal—a shortfall of over 40%.

The issue of shortfall and delays in payment of compensation dominated the GST Council meeting held on June 12. All that the Centre and states could agree on was to call another meeting of the Council ‘shortly’ to exclusively discuss the compensation issue.

The possible options for resolving this issue are: 1) expand the list of commodities for levy of cess or raise the rate of cess, 2) GST Council borrowing to meet the shortfall in cess collections, 3) allowing states additional market borrowings to the extent of the shortfall in compensation, and 4) Centre to meet the shortfall from its consolidated fund.

In the current situation when the pressing need is to stimulate the economy, the first option of expanding the cess, which will be a drag on the economy, is neither practical nor desirable. The second option—GST Council borrowing from the market—is questionable. The Council is a constitutional body, not a corporate entity that can tap the market. The third option of allowing states additional borrowing limits is hardly tenable. Why should states accept this additional debt burden in lieu of a payment that they believe they are entitled to? That leaves the fourth and the last option of the Centre dipping into its consolidated fund as the only viable alternative.

In the matter of GST, states feel aggrieved on many counts. First, to enable a transition to GST, they have yielded more fiscal space than the Centre. GST has subsumed around 47% of the gross tax revenues of the states as compared to only 31% of the Centre’s. Furthermore, though Union excise duties and service tax were subsumed under the GST, the Centre is still left with 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 RBI and central PSUs.

Second, states believed that the introduction of GST would put an end to the egregious practice of the Centre levying cesses and surcharges, which are not shareable with them. That expectation has been belied. The Union Budget of 2018-19 increased rates of education and health cesses and imposed a social welfare surcharge on a number of imported goods. The Union Budget of 2019-20 raised the road cess on petrol and diesel by Re 1 per litre. The Union Budget 2020-21 introduced a health cess on imported medical devices. The cess on petrol and diesel has been further increased to `9 per litre during the current year. States feel, justifiably, that instead of levying cesses, the Centre should have increased the basic rates so that they too got a share of the additional collections.

Finally, states are anguished that even as the burden of fighting the pandemic has disproportionately fallen on their shoulders, the Centre has not been sufficiently sensitive to their deep fiscal woes.

It is reported that the opinion of the solicitor general is that the Centre is not legally obliged to pay the full compensation. The Centre may not have a legal obligation, but it certainly has a moral obligation. The states have been very accommodative right from the beginning in moving the GST process forward, and the Centre needs to reciprocate.

(Author was Economic Adviser in the Ministry of Finance, and is currently Adviser to the Government of Telangana. Views are personal)

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