Should GST compensation be extended beyond 2022?

GST

The 43rd GST council took place on May 28 under the shadow of the COVID-19 second wave. As expected, the issue of compensation to states was a key issue of discussion apart from changes in GST rates on supply of goods and services, and changes related to GST law and procedure. As we know, states agreed to join the new tax regime provided they were compensated for any revenue loss in the first five years from July 1, 2017 to June 2022.

Today, state governments are struggling with their declining revenue and increased expenditures. The lower revenue growth curtails growth in expenditure and it seems that any revenue loss will further hurt spending. The main source of revenue for states are taxes. According to their budget for FY21, about 70 percent of revenue comes from taxes. The revenue growth for states in the current fiscal is nearly zero percent as compared to previous year. The second wave and accompanying lockdowns are likely to impact revenue this year too. It will lead to states demanding a higher compensation.

Section 18 of the Constitution (101 amendment) Act, 2016 and Section 7 of GST (Compensation to State) Act, 2017 permits that the loss of revenue will be compensated to states at the end of every two months for five years. The shortfall is calculated assuming a 14 percent annual growth in GST revenue over the base year of 2015-16. Now, two questions arise: One, whether the compensation period should be extended; and, two, whether the compensation amount should be calculated at 14 percent revenue growth rate.

First, we are in the last of the five-year compensation period promised to states. Some states are asking that the period of compensation be extended. Rajasthan Chief Minister Ashok Gehlot has written to Prime Minister Narendra Modi and asked that the payment of GST compensation to states be extended till 2027. The experts of Gulati Institute of Finance and Taxation (GIFT), which is affiliated to the Cochin University of Science and Technology, are of the same view, and argue that as long as there is GST there should be GST compensation for states.

India is moving towards a one-nation, one-tax concept. Thus, the absence of GST compensation threatens the concept of GST. In this backdrop, Finance Minister Nirmala Sitharaman assured states that a separate meeting of the GST council will be held to discuss the issue of extending the GST compensation beyond 2022.

Second, whether the compensation should be calculated at 14 percent revenue growth. As per GIFT, while states had surrendered 51.8 percent of total tax revenue, the Centre sacrificed only 28.8 percent of gross tax revenue for entering into the GST regime. This means that the cost of the introduction of the GST was not shared equally by the Centre and states, but they are sharing the GST revenue equally. This strengthens the case for the states to get compensated at 14 percent.

At the same time, one must not forget to see the issue at hand from the Centre’s point of view.

We should not forget that the ongoing pandemic is not only affecting the revenue of states, it is impacting the Centre too. The Centre’s total revenue has declined by 23 percent, the gross tax revenue by about 21.6 percent, and the  expenses have surged 13.4 percent in FY21. Hence, the fiscal deficit reached to Rs 18.2 lakh-crore (9.3 percent of the GDP) and Debt/GDP to about 90 percent.

Given this, is it right on the part of the states’ demand of a 14 percent compensation? Would the Centre be able to compensate at that rate? Former Chief Economic Adviser Arvind Subramanian has suggested that the Centre and states negotiate a one-off political solution considering the effect of the pandemic on the economy.

The Centre, through the statement by Revenue Secretary Tarun Bajaj, has made its stand clear that the government will take the same methodology and formula as last year to calculate the gap for FY22. He expects the states’ revenue deficit would be around Rs 1.58 lakh-crore this fiscal. The Centre has estimated the total state revenue deficit of Rs 2.69 lakh-crore, and expects to collect over Rs 1.11 lakh-crore though cess. Hence, Rs 1.58 lakh-crore would be borrowed this year. The formula for compensation borrowing is in place since 2020.

In the last fiscal, the government calculated Rs 2.35 lakh-crore of the total revenue deficit for states after deducting the compensation cess of Rs 0.65 lakh-crore. The deficit was further bifurcated into GST revenue shortfall (Rs 0.97 lakh-crore) and the rest was owing to the pandemic. In FY21, the Centre had borrowed on behalf of the states and released Rs 1.10 lakh-crore for compensating the states.

It is hoped that this year the states will be entirely compensated by the Centre as the government is sure that the GST revenue collection will follow the same path it has followed since October 2020. Data issued by the Controller General of Accounts for April 2021 also shows that there will be limited impact on the economy as compared to 2020.

All said, it is likely that the Centre and the states will find a middle way on GST compensation.