The Goods and Services Tax (GST) regime will turn five years in June, marking the end of the period for which states were assured compensation in case collections fell short. At the time of its introduction, the revenue of the states covered under GST was legislatively protected for a transition period of five years from FY18 to FY22. Any shortfall – relative to a steady growth of 14% p.a. on FY16 revenue base – had to be funded through the imposition of a compensation cess on sin and luxury goods, on items such as aerated drinks, coal, pans. is applied. Spices, cigarettes and automobiles exceed the peak GST rate of 28%.
The financial condition of the state governments is not very good after the pandemic fell on the exchequer. And, the GST collection is missing the 14% growth target, as the pandemic has hit consumption spending in the economy as well. And therefore, states want the Center to continue to compensate them for the shortfall of their GST revenue beyond 2022. Taksal has told The GST Council meeting, scheduled to be held in the second half of April, is expected to be a stormy one as the Centre, in financial crunch, is reluctant to extend additional support to states for fear of disturbing their fiscal calculations. ,
Do the states have a case? The GST compensation for the three financial years, FY18, FY19 and FY20, has already been paid to the states. Compensation cess collection was sufficient to meet the shortfall in GST collections of the state governments in FY18 and FY19. But the slowdown in GDP in FY2010 led to a reduction in cess collections, which got worse in FY2011 due to the impact of the pandemic. The combined impact of the hit on GST and Cess collections increased the need for compensation during the pandemic.
The Centre, whose finances were badly hit by the pandemic, decided to borrow in October 2020 1.10 lakh crore from the market and pass in the form of back-to-back loans to the states in lieu of compensation cess for FY2011. In fact, the Center provided compensation during the pandemic through two different means: Loan Plus 0.91 lakh crore out of GST Compensation Cess collection. The same was done for FY22. the center borrowed 1.59 lakh crore from the market through a special window and passed as back-to-back loans to the States/UTs. Like last year, Center also released Compensation Cess 60,000 crores.
Neither principal nor interest will be paid on loans taken by the Center for payment of compensation cess and shortfall in GST collection by states. They are not required to bear any cost for the loan. To enable the Center to repay loans taken to compensate states for shortfall in GST collection, the GST Council voted last September to levy a compensation cess by March 2026. The collection is to be used to repay back-to-back over this extended period. Loans taken by the Center in FY 2011 and FY 2012 to pay compensation to the states. It was not meant to compensate the states for an extended period.
Now the states are demanding a share in these cess collections. If this is agreed, how will the Center repay the loan?
The fact is that the weakness in the economy before the covid pandemic is one of the reasons for the GST collection. With GDP growth slowing, GST collections could not have grown at 14%. When income is not increasing, consumption rarely will. The absurd design and rate structure of GST is a contributing factor for this economic weakness. The biggest blame for this mess goes to the states. Former Chief Economic Adviser Arvind Subramaniam in his articles has recorded details about the deliberations between states and the Center before the rollout of GST, wherein state after state were only interested in the new tax system, as far as May imitate the complex tax system. was to be replaced. If GST is meant to replicate the system it is replacing, why bother with a new system?
But states had so little faith in reforms that they demanded a price to allow GST to be introduced: guaranteed compensation for the absence of revenue growth for five years, unrealistic GST collection growth targets, an absurd rate structure. which has not been seen anywhere. The world, and the major revenue generators of fuel, alcohol and real estate continue to be outside the GST. The option for the Center was to either abandon the reforms or agree to these impractical terms. It chose the latter. Moreover, as the economy fell into a GDP contraction despite the Covid-19 shock, the Center and states agreed to maintain a 14% growth spurt to compensate for the pandemic years.
What’s the best way now? Ensuring that states have money to spend is critical to GDP recovery, as their spending drives economic growth more than the Centre. But if the Center wants to come under pressure from the states again, it will have to set firm, non-negotiable conditions for agreeing to extend the compensation period beyond FY22: First, the amount of extended compensation under any circumstances. The period shall not exceed three years. Second, the shortfall to be compensated cannot be determined by a 14% increase in the GST collection target; Year-on-year GDP growth should be the only criterion. This will make compensation realistic, and it will also reduce the dissatisfaction and complacency of the state GST officers to collect tax efficiently. For which compensation should be deducted and reduced by one third every year. Finally, states should agree to reform GST by simplifying the rate structure and removing all exemptions to bring alcohol, fuel and immovable property under GST. Without this the economy would not get the real benefits of the reforms.
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