Opinion: GST compensation imbroglio—It takes two to tango!

The Centre and the states need to sort out the compensation issue amicably.

By Rahul Renavikar

The recently-concluded 41st GST Council meeting was keenly followed by all stakeholders in the Indian economy.
The biggest takeaway for Trade and Industry was that there was no discussion, and hence no decision on either increasing the existing GST rates or enhancing the ambit of the levy of GST Compensation Cess in view of the huge shortfall in the GST revenues expected in FY21.

The Centre cleared its position on the liability to pay compensation to the state governments. With the two options given to the states to choose from, it sent a strong signal to the states that the Centre is unwilling to foot the bill, though willing to facilitate borrowing by the states. So much for co-operative federalism!

After three years of implementation, in hindsight, it now appears that agreeing to compensate the states for any GST revenue shortfall, that too at a 14% compounded growth rate for five years, was a tall order.

With no linkage to GDP growth rate during the same period, and with petroleum products, electricity, alcohol (fully) and real estate (partially) kept out of GST, it was a recipe for disaster. The economy was doing good in 2015 and 2016, and hence, there was a tinge of optimism in the blanket 14% annual increase in revenue for computaion of compensation to all states.

At the time, there were many states whose revenues from those taxes subsumed under the GST were hardly growing in single-digits. A 14%-guaranteed increase in revenues, that too at a compounded rate for five years, was like a windfall for these states, which never objected then. Why would they?

In fact, it would have made these states very complacent in all matters relating to GST, including its implementation, once they got this assurance from the Centre. The Centre perhaps should have adopted a differential approach, depending on pre-GST tax revenues of the states, and devised a band of compensation slabs.

It is now amply clear that the Indian economy started to face headwinds in FY17 (the year in which DeMo happened). FY16 was used as the base year for calculation of GST shortfall, not FY17, the year immediately preceding the GST implementation year.

The GDP growth rate was around 8.2% in FY16, by far the highest in the last five years or so. It slid to 7.1% in 2017. By FY19, it was 6.1%, and it is estimated that the growth rate will be around 4.2% in FY20. Taking FY16 as the base year for calculating the compensation for GST losses has proven to be an additional burden.

As if this was not enough, Covid-19 hit the economy hard, starting mid-March 2020. The pandemic necessitated lockdowns globally. But, India went into a complete lockdown that was announced without giving any time to Trade and Industry to plan activities that could have facilitated smooth operations.

In India, the consumption of those goods and services that were either exempted from GST (essentials) or were outside the GST ambit was at a peak during the lockdown period. No doubt, the Centre and the states got their respective share in revenues either in the form of excise duty or state VAT or state electricity duty from consumption of these products/services.

However, had these been included in the GST ambit, the compensation amount may have been far less. For this purpose alone, these ought to have been included in the GST ambit, ab initio. The Centre has estimated that the share of states in the shortfall in GST collections for FY 21 would be in the range of Rs 3 lakh crore, of which around Rs 65,000 crore would be funded through the GST compensation cess that will be collected during FY21.

This leaves a shortfall of Rs 2,35,000 crore, of which the Centre has attributed Rs 97,000 crore on account of GST roll-out and the balance of Rs 1,38,000 crore to the Covid-19 pandemic. Without going into number crunching, the discussions/reactions from the states on the two options proposed by the Centre are being played out in full public glare.

We already have a few states that have voiced their rejection of the two options, and the list is increasing. Surprisingly, the chief minister of a large state has gone on record to suggest that a review of the GST implemented be undertaken and be compared with the erstwhile indirect tax regime!

All in all, it seems that the argument between the Centre and the states is going to spillover from the aegis of the GST Council; it is headed for a long battle where the judiciary may also get involved at some point in time unless the Centre and the states patiently thresh out the problem at hand and arrive at an amicable solution.

The last thing that Trade and Industry wants in these testing times is discord between the Centre and states on fiscal matters. After all, it takes two to tango!

The author is MD, Acuris Advisors Pvt. Ltd. Views are personal.

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