GST Compensation Issue and cooperative federalism

Source: Indian Express

Context: Issue of compensating states for the loss of their GST revenues

What is the background of the issue?

• Creation of the GST Council in 2017, to levy GST (unified domestic consumption tax) was hailed as a great example of cooperative federalism.
• Concerned with loss of revenue due to the new GST regime, states wanted a firm assurance from the Centre to compensate for their revenue shortfall.
• Accordingly, States were guaranteed compensation for any revenue shortfall below 14% growth (base year 2015-16) for the first five years ending 2022.
• It was agreed that the GST compensation will be paid out of Compensation Cess for every two months by the Centre to states
• In case the amount in the GST compensation fund falls short of the compensation payable in any bi-monthly period, the GST Council shall decide the mode of raising additional resources including borrowing from the market which could be repaid by the collection of cess in the sixth year or further subsequent years.
• Due to the pandemic, the revenue collected through cess by the centre is not sufficient to compensate for states GST losses.
• So, the centre has come up with two options for the states to settle the issue.

What were the options provided for the states?

• According to the Centre, the estimated states’ total loss of GST revenue is Rs 3 lakh crore. Out of which, Rs 65,000 crore was expected to accrue from the compensation cess.
• To compensate the remaining Rs 2.35 lakh crore, the centre came up with two options.
  • Special window to borrow: The first option was to provide states a special window to borrow Rs 1.1 lakh crore from the RBI. Under this option, both the interest payments and the repayments would be made from future collections of the compensation cess.
  • States to borrow entirely: As per the second option, the states can borrow the entire shortfall of Rs 2.35 lakh crore from the market. Unlike the first option, the states have to bear the interest costs and the repayments would be adjusted against future collections of the cess.
• While few states are willing to abide by first option, some states have rejected both the options and have stated that it is the Centre’s responsibility to compensate the states, and therefore, the centre should borrow.

Why it concerns cooperative federalism?

• The two options were presented without any discussion in the council and mandated the states to choose one of the options within a week.
• States are being pressurised to accept any of the two options. For example, Recently, there was a statement that those states which do not exercise their option within a week have to wait until 2022.

What is the way forward?

• It is the Centre’s commitment to find the compensation mechanism.
• Given the relative fiscal strength of the Centre and the states and as the interest rate of the Centre’s borrowing is lower than that of the states, the Centre should take the responsibility to borrow.
• Further, interest payments and repayment of the principal liability can be met from future collections from the cess.

This is not merely a matter related to compensation for the loss of revenue but has to do with the credibility of honouring the agreement. Pressuring states will have adverse consequences for the country’s federal structure.