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Explained | Why GST Council can't arrive at a consensus on compensation issue

The vexed issue of GST compensation cess has put the government in a bind. Opposing states contend that the government is constitutionally bound to compensate them and are not willing to accept the options provided by the Centre.

October 15, 2020 / 07:25 PM IST

Even after continuous meetings, the Goods and Services Tax (GST) Council  in its meeting on October 12 failed to reach a consensus on borrowing options in lieu of the compensation cess shortfall. Finance Minister Nirmala Sitharaman then said that some states questioned whether the Council had any authority to disallow those states that have already opted for one of the borrowing options from going ahead with their borrowing plans.

The next day, the government allowed 20 states to raise an additional Rs 68,825 crore through open market borrowings.

"Additional borrowing permission has been granted at 0.5 percent of the Gross State Domestic Product (GSDP) to those states who have opted for option 1 out of the two options suggested by the Ministry of Finance to meet the shortfall arising out of the Goods & Services Tax (GST) implementation," the government said in a press release.

What is the compensation issue?

The Indian economy was in a slowdown even before the COVID-19 pandemic hit India. This was reflected in the weak economic indicators and a slowing GST collection. In October, payments to states were delayed as the collection was lower than expected.

Under GST law, states were guaranteed to receive payment for any loss of revenue in the first five years of the GST implementation, from July 1, 2017. The shortfall is calculated assuming a 14 percent annual growth in GST collections by states over the base year of 2015-16. States have been promised compensation for any revenue shortfall till 2022, in case they go below the 14 percent annual growth since the GST rollout in 2017.

The amount due to states started rising at a compounded rate of 14 percent, despite compensation collections not showing any major upward movement for two consecutive years. For the April-June period, Rs 14,675 crore has been collected as compensation cess, of which Rs 7,665 crore was collected in June. The Centre cleared Rs 36,400 crore for the November-February period in June. In July, the Centre released Rs 1.65 lakh crores as GST compensation to states/Union Territories for the financial year 2019-20, against cess collection of Rs 95,444 crores.

Is the Centre not paying states their dues?

The problem of drying revenues was exacerbated by the Covid-19 pandemic and the ensuing lockdown. Economic activities came to a standstill, and even after the resumption of the economy, consumption is at an all-time low. FY2020-21 is bound to be a difficult year as consumer sentiment is seen to be dipping due to the Covid-19 pandemic.

To resolve the compensation issue, in its August 27 meeting, Sitharaman had proposed two options to states - to either borrow Rs 97,000 crore (on account of GST implementation) through a special window facilitated by the RBI, or to borrow the complete shortfall of Rs 2.35 lakh crore (including Rs 1.38 lakh crore due to COVID) from the market. The amounts under the two options have since been revised to Rs 1.10 lakh crore and Rs 1.8 lakh crore, respectively.

The GST Council earlier this month approved extension of the GST compensation cess levy beyond 2022. "Levy of Compensation Cess to be extended beyond the transition period of five years i.e. beyond June, 2022, for such period as may be required to meet the revenue gap. Further details to be worked out," the ministry had said in a statement.

Why are states not accepting the offers?

Twenty states have agreed to accept option 1 to meet the compensation deficit. However, the rest of the states have not agreed to either of the two options given by the Centre. The opposing states have been pushing for a third option, where the Centre borrows on behalf of the states, because states felt that debt to meet the compensation gap on states' balance sheet might limit their borrowing capacity in future.

The Centre had provided an additional borrowing limit of up to 2 percent of GSDP to states. The final instalment of 0.5 percent out of this 2 percent limit was linked to carrying out at least three out of four reforms stipulated by the Centre. The reform condition attached to the 0.5 percent instalment has been removed.

The guiding principle of GST Council decisions since its inception has been unanimity. On grounds where unanimous decisions failed to take place, the issues were looked into through other methods, like constituting a Group of Ministers to arrive at conclusions.

However, on the compensation issue the GST Council has failed to arrive at a consensus. Opposing states have said that the Centre is Constitutionally bound to provide compensation to states and cannot ask states to borrow.
The Centre believes that Covid-19 is an extraordinary situation and unforeseen. The Centre has had to already increase its borrowing plan for FY2020-21 to fund expenditure. Further addition to its debt would immediately jack up bond yields. Increased borrowing costs is not something that the government can afford at a time when India is looking at more money to invest and to borrow to do business.

Kamalika Ghosh