GST shortfall:

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Context:

The Centre has presented two options before the states to bridge their goods and services tax (GST) revenue shortfall. They are:

1. States borrow Rs 97,000 crore, which is the estimated shortfall, only “on account of GST” under a special window to be facilitated in consultation with the Reserve Bank of India (RBI) at a ‘reasonable G Sec-linked interest rate’.
2. They borrow the entire Rs 2.35 lakh crore. There also, arrangement could be made with the RBI and certain facilities could be provided.

The loans will be serviced via the proceeds of the relevant compensation cess, which will apply on the specified demerit goods for a year or more beyond the current end date of FY22.

What’s the issue?

The GST Compensation Act, 2017 guaranteed States that they would be compensated for any loss of revenue in the first five years of GST implementation, until 2022, using a cess levied on sin and luxury goods.

• However, the economic slowdown has pushed both GST and cess collections down over the last year, resulting in a 40% gap last year between the compensation paid and cess collected.
• States are likely to face a GST revenue gap of ₹3 lakh crore this year, as the economy may contract due to COVID-19, which Finance Minister Nirmala Sitharaman termed an unforeseen “act of God”.

What is compensation cess?

The modalities of the compensation cess were specified by the GST (Compensation to States) Act, 2017.

• This Act assumed that the GST revenue of each State would grow at 14% every year, from the amount collected in 2015-16, through all taxes subsumed by the GST.
• A State that had collected tax less than this amount in any year would be compensated for the shortfall. The amount would be paid every two months based on provisional accounts, and adjusted every year after the State’s accounts were audited by the Comptroller and Auditor General.

This scheme is valid for five years, i.e., till June 2022.

Compensation cess fund:

A compensation cess fund was created from which States would be paid for any shortfall. An additional cess would be imposed on certain items and this cess would be used to pay compensation.

• The items are pan masala, cigarettes and tobacco products, aerated water, caffeinated beverages, coal and certain passenger motor vehicles.
• The GST Act states that the cess collected and “such other amounts as may be recommended by the [GST] Council” would be credited to the fund.

 Challenges ahead:

Most economists expect negative real GDP growth this year, and nominal GDP to be close to last year’s level.

• As indirect taxes are levied on the nominal value of transactions, this is likely to result in significant shortfall for States from the assured tax collection.
• A key source of the problem is that the 2017 Act guaranteed a tax growth rate of 14%, which is unachievable this year. Whereas no one could have foreseen the pandemic and its impact on the economy, the 14% target was too ambitious to start with.

What needs to be done?

The Central government is constitutionally bound to compensate States for loss of revenue for five years.

There are several possible solutions to this issue:

1. The Constitution could be amended to reduce the period of guarantee to three years (thus ending June 2020). This would be difficult to do as most States would be reluctant to agree to this proposal. It could also be seen as going back on the promise made to States when they agreed to subsume their taxes into the GST.
2. The Central government could fund this shortfall from its own revenue. States would be happy with this proposal. However, the Centre’s finances are stretched due to shortfall in its own tax collection combined with extra expenditure to manage the health and economic crisis. It may not be in a position to give further support to States.
3. The Centre could borrow on behalf of the cess fund. The tenure of the cess could be extended beyond five years until the cess collected is sufficient to pay off this debt and interest on it.
4. The Centre could convince States that the 14% growth target was always unrealistic. The target should have been linked to nominal GDP growth. If the Centre can negotiate with States through the GST Council to reset the assured tax level, it could then bring in a Bill in Parliament to amend the 2017 Act.

Sources: the Hindu.