The Centre must support states for a couple of more years, even if it is to a smaller extent than the current 14%
Given the absence of a categorical commitment by the finance minister, the Centre clearly remains reluctant to compensate states for revenue shortfalls beyond June 2022. The government has stressed the point that collections from the cess until March 2026 would be needed to repay borrowings that are being made to compensate states for revenue shortfalls.
While some chief ministers believe the discussion on compensation has been deferred to the next meeting and that the Centre will come up with a proposal, given how the FM and the revenue secretary repeatedly stressed the law required compensation to be paid for just five years, this appears unlikely. If the compensation issue is to be deliberated upon by a GoM, as one minister has said, surely the FM would have make that clear. While it may soften its stance later, for the moment, it appears the states will have to learn to live without compensation for revenue shortfalls post July 2022.
While it is true that GST revenues have been fairly robust over the last few months, and revenues from other sources too should pick up as the economy recovers, given the weak state of the finances of some states, the Centre should support them at least for a couple of years. The fact is states should not be short of resources to make meaningful capital expenditure given the nascent recovery. If not up to 14%—the current level of annual revenue growth projected—the Centre could offer some support. It is true they have been allowed additional borrowings, but that would only strain their balance-sheets. State GST (SGST) has accounted for two-fifths of the aggregate own tax revenues of state governments in the last three years. At the same time, it is also true that the cess proceeds have been falling short of the amounts needed to compensate the states since FY20, with the gap widening dramatically in FY21. The shortfall in the current year is estimated at a fairly sizeable Rs 1.59 lakh crore, despite the robust GST receipts in recent months.
One important revelation that the 45th GST Council meeting in Lucknow threw up is that the revenue neutral rate, originally envisaged at 15.5%, has actually slipped to 11.6%. This is not surprising given the several arbitrary cuts and ‘rationalisation’ that has taken place for which both the states and the Centre must accept responsibility. While it is not going to be easy to hike the rates given the pandemic, the GoM looking into rationalisation of the rate structure must try and prune the number of rates. Some course correction, in terms of rectifying inverted duty structure, was done at the Lucknow meeting. Moreover, steps have been taken to curb evasion by small food outlets, which, hopefully, will not hit those not liable to pay taxes.
But, even while the weak state of the economy is a handicap, we must aim to make the GST structure stronger in the not-too-distant future. For the moment, it would be difficult to remove any products from the 28% slab. One should not expect petroleum products will be brought into the GST net anytime soon; the subject was on the agenda purely due to a Kerala High Court order. Neither the states, nor the Centre, would want to give up what is now a lucrative revenue source. The formalisation of the economy has helped boost GST collections, and these can be further enhanced through improved compliance, plugging leakages, and beefing up technology.