7 PM Editorial |Issue With The GST Compensation Plan By The Centre|19th September 2020

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Issue With The GST Compensation Plan By The Centre

Topic: GS-2&3, Polity & Economy

Sub-Topic – Issues and Challenges Pertaining to the Federal Structure, Mobilization of Resources

Overview – The issues with devolution of taxes to the States because of the Economic Slowdown.


The GST council meeting has been deferred to the first week of October due to sharp differences between the Centre and the States. These differences have arisen due to the huge revenue shortfall experienced by both Centre and States. The Centre had brought the States on board GST by promising higher revenue collection. Producing States such as Gujarat were sceptical because GST is a destination based tax which is collected proportionately more in consuming States such as Bihar. States were lured by the promise of 14% annual growth in GST revenue over the base year of 2015-16. Any shortfall from this (for five years) was to be compensated by levying a cess on luxury and sin goods. But now the Centre is trying to go back on its claims of reimbursing the states.

What is the Centre’s plan?

In the last GST Council meeting, the Centre gave the states two options:

  1. The states could borrow ₹97,000 crore (the shortfall in the GST revenue compensation) from the Reserve Bank of India (RBI) under a special window at a low rate of interest.
  2. Or the states could borrow ₹2.35-lakh crore(the total compensation shortfall) from the market with the RBI facilitating it.

The Centre assured that the burden of repayment would be borne by the future collections from the compensation cess. It was proposed that this cess which was to end in June 2022 could be extended to facilitate the repayment of the debt. The states are however wary of the fact that the Centre is trying to go back on a promise mentioned in the GST Act itself and so any assurance now is not being believed upon by the states. Even the figures mentioned in the Centre’s plan have not been accepted by the states. The condition of the economy suggest a higher shortfall than the figures that Centre has used to calculate the borrowing amount.

What do the growth trends of different sectors suggest about growth?
  1. Corporate sector profits will fall sharply. Some sectors such as fast-moving consumer goods, and e-commerce will do well. But companies in sectors such as airlines, hotels and consumer durables will show losses and therefore pay little tax. Thus, corporation tax collection will fall sharply — much more than 20% compared to the budget estimate.
  2. Income tax collection will fall since a large number of workers have lost employment and have faced salary cuts. Many private firms are also likely to incur losses. So, income tax collection will also be short by much more than 20%.
  3. GST collection will also be short by much more than 20%. The production of luxury and sin goods has been severely impacted and they pay the high rate of tax — 18%, 28% and cess on top. The essential production which is affected less by lockdown either pays 0%, 5% or 12%.
  4. Due to a drastic fall in imports, the Integrated Goods and Services Tax (IGST) and customs duties will also decline. The extra tax collected on petroleum products will help counter the decline to an extent.
What does these figures add up and say about the Centre’s borrowing offer for states?

Direct Taxes

If GDP falls by 10% over last year, instead of being ₹224-lakh crore, it will be about ₹184-lakh crore. Using the lower tax/GDP ratio, direct tax revenue will be short by ₹5-lakh crore compared to the budgeted amount. This is an optimistic guess. The States’ share of all taxes collected by the Centre is 42%, so they will lose ₹2-lakh crore.

Indirect Taxes

The indirect tax/GDP ratio can be expected to fall from 10.5% to 8% resulting in a drop of ₹7 lakh crore. About 60% of this loss will be from GST and half of that would be the loss of States. About half of the remaining part (₹2.8-lakh crore) will also be a loss of States.

Loss from GST= 60%*7=4.2 lakh crore. So loss for states=4.2/2=2.1 lakh crore.

Of Centre’s share of 2.1 lakh crore, States will lose 42%, i.e. 42%*2.1=88000 crore.

Of remaining 2.8 lakh crore, States lose half, i.e. 1.4 lakh crore.

All these add up to 6.4 lakh crore (2 lakh crore from direct taxes and 4.4 lakh crore from indirect taxes).


If the economy declines by only 10%, the States will lose ₹6.4 lakh crore. The States GST revenue will be short by ₹3-lakh crore which should be compensated by the Centre. Subtracting from this the expected collection of ₹65,000 crore from cess we get the figure of ₹2.35-lakh crore. Even if the States take the loan of ₹2.35-lakh crore they would have an uncovered deficit of ₹4-lakh crore. Also, there is a 10% decline in GDP that is used to calculate. If the fall is further downwards, it will be a precarious shortfall. The Centre with more borrowing power, thus, needs to do the borrowing.

Source: The Hindu

Mains Question:
  1. Is the Centre’s plan to ask the states to borrow for making up the GST compensation shortfall a step in the right direction? DIscuss this in the context of cooperative federalism.
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