GST Compensation issue

In News: Centre-state friction is growing over pending GST compensation payments issue under the Goods and Services Tax (GST).  The Finance Minister noted that the financial crisis facing the States is a result of an “act of God”.

About GST

The Goods and Services Tax in India is comprehensive, multi-stage, destination-based value-added indirect tax. It has replaced many central and state indirect taxes in India such as the excise duty, VAT, services tax, etc.

GST compensation: As per the GST (Compensation to States) Act, 2017, states are guaranteed compensation for revenue loss on account of implementation of GST for a transition period of five years (2017-2022).

• The compensation is calculated based on the difference between the current states’ GST revenue and the protected revenue after estimating an annualised 14% growth rate from the base year of 2015-16.
• Any shortfall has to be compensated from the receipts of Compensation Cess imposed on selected commodities that attract a GST of 28 percent.
• At present, the cess levied on sin and luxury goods such as tobacco and automobiles flow into the compensation fund.

Issues between Centre and States over GST compensation:

• The constitutional mandate not followed: Centre needs to honour the constitutional promise and reimburse the shortfall in tax revenues.
• Issues of compensation: As per the estimates, the States’ GST revenue gap in 2020-21 will amount to about ₹3 lakh crore, while cess collections are only projected to reach ₹65,000 crore, leaving a shortfall of ₹35 lakh crore.
• Manufacture and sale of liquor is one of the major sources of state’s revenue: the centre has placed restrictions on bars/liquor sale for long time. Excise duty on alcohol accounts for around 10-15 percent of Own Tax Revenue of a majority of states.
• Less taxation power with states: Using cess for agriculture such as Krishi Kalyan cess and Swachh Bharat cess, the Union is entering domains that are a part of the state list.
• Against fiscal federalism: Unilateral decision by Centre without negotiation can jeopardise the future of GST, which was envisaged as a cooperative initiative.
• Increase burden on taxpayers: The reliance on future compensation means that taxpayers will have to bear the cost.
• State’s opposition: Finance Minister of Kerala said enforcing a cut in compensation and bringing in a distinction between GST and Covid-related revenue loss is unconstitutional. The Chief Minister of Maharashtra has said that it is time to exit the GST. Punjab, Chhattisgarh and Puducherry have voiced their displeasure.
• Stress the finances of the states’: If compensation is not paid to states, economy of states will fail because GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.
• Role of agencies in slowdown: During tight Monetary policy in 2017 and 2018 agencies showed higher growth than what actually obtained in 2016-17 and 2017-18. This affected structural reforms and the monetary policy of RBI.

• Moral obligation to compensate states from the Consolidated Fund of India: Centre is morally obligated to pay compensation to States as states gave away their right of taxation.

Way forward:

• Extend compensation period: Centre can prolong the compensation period beyond July 2022 and offer a greater share of the revenues (the SGST part) to the States.
• Address trust deficit: The Centre needs to deliberate with the states and bridge the alarming trust deficit.
• Reconsider FRBM limit: The centre should allow the states to exceed the FRBM limit by more than 0.5 per cent of the SGDP, as a temporary relief.
• Facilitate borrowing by the states without affecting their debt to GDP ratios.
• Fiscal decentralisation: Of the 12% GST, 10% should be equally shared between the States and the Centre, and 2% must be earmarked exclusively for the urban and rural local bodies, which ensures some basic revenue autonomy to them.
• Single rate GST: There was an original recommendation of a standard rate of 12%, to be fixed for at least a five-year period. It reduces the need to do arbitrary classification and discretion, reduces litigation and will lead to buoyancy in collection. For example; Australia’s GST rate which has been constant at 10%.
• Widen the tax base: GST should progressively include all goods (petroleum and alcohol) and services with very few exceptions, such as food and medicine.

Conclusion: GST is a crucial and long-term structural reform which can address the fiscal needs of the future. Therefore, there is need to strike the right and desired balance to achieve co-operative federalism which will lead to enhanced economic growth.