GST Compensation disagreement between the Centre and the States

Source- The Hindu

Syllabus- GS 3- Government Budgeting.

Context- The onus would be on Centre to resolve this impasse with regard to compensation cess of GST reforms.

What is GST compensation?

  • The Centre is obliged to pay to the States, for a period of five years, compensation for revenue shortfalls in return for their having ceded the power to levy the multiple taxes that were subsumed into the GST.
  • The compensation is calculated based on the difference between the states current GST revenue and the protected revenue after estimating an annualized 14% growth rate from the base year of 2015-16.

What is current GST compensation situation?

  1. Pending payment– GST compensation payments to states have been pending since April, with the pending amount for April-July estimated at Rs 1.5 lakh crore.
  2. GST revenue gap– The GST compensation requirement is estimated to be around Rs 3 lakh crore this year, while the cess collection is expected to be around Rs 65,000 crore – an estimated compensation shortfall of Rs 2.35 lakh crore.

What were the Options given by the Center to the States?

Options made by the Centre-

Option 1 –

  • To provide a special borrowing window to states, in consultation with the RBI, to provide Rs 97,000 crore at a “reasonable” interest rate and this money can then be repaid after 5 years by extending cess collection.
  • A 0.5 percent relaxation in the borrowing limit under the Fiscal Responsibility and Budget Management [FRBM] Act would be provided.

Option 2

  • To meet the entire GST compensation gap of Rs 2.35 lakh crore this year itself after consulting with the RBI.
  • No Fiscal Responsibility and Budget Management Act relaxation has been mentioned for this option.

Issues raised by the States-

  1. Several Sates have rejected both options and some, including Tamil Nadu- have urged the Centre to rethink in view of their essential and urgent spending needs to curb the pandemic and spur growth.
  2. Enforcing a cut in compensation and bringing in a distinction between GST and Covid-related revenue loss is unconstitutional.
  3. The two options offered to the States would impose huge debts on the states and as a result many would not even be able to pay salaries.
  4. States simply do not have the headroom to borrow money to make up for the GST shortfall as every single State has reached its FRBM [Fiscal Responsibility and Budget Management] limit.

What are the expected reasons for Revenue shortfall for the fiscal year 2020-21?

  1. Corporate tax collection loss – Companies in sectors such as airlines, hotels and consumer durables will show losses and therefore, pay less tax.
  2. Less income tax collection– Large numbers of workers have lost employment and/or 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. Less import – The Integrated Goods and Services Tax (IGST) and customs duties will also decline with fall in import.
  4. The production of luxury and sin goods has been severely impactedand they pay the high rate of tax — 18%, 28% and cess on top.
  5. The direct tax/GDP per cent may be expected to fall from 5.5% last year to less than 4% this fiscal.

Way forward

Center needs to renege on its promise to find ways to compensate the state for loss of revenue. Only the Centre is in a position to do such massive borrowing as Reserve Bank has itself said that for the Central government to borrow would be both easier and simpler. Central government would pay 2% less interest than the states.

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