The article deals with the issue of shortfall in the GST compensation cess and the challenge Central government faces to pay the promised compensation to the states.

Background of the cess

• GST subsumed several taxes, including those which were the preserve of the States.
• Therefore it required an amendment to the Constitution of India.
• The amendment affected the Seventh Schedule, so it required ratification by the legislatures of half the States.
• Before the GST, States exporting goods to other States collected a tax.
• But the GST is a destination-based tax, i.e., the State where the goods are sold receive the tax.
• This implies that manufacturing States would lose out while consuming States would benefit.
• So, in order to convince manufacturing States to agree to GST, a compensation formula was created.
• Under which States were promised compensation for loss of revenue for a period up to five years.
• The Act for compensation to states assumed that the GST revenue of each State would grow at 14% every year, from the amount collected in 2015-16.
• 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 Act states that the cess collected and “such other amounts as may be recommended by the [GST] Council” would be credited to the fund.
• In the first two years of this scheme, the cess collected exceeded the shortfall of States.
• In the third year, 2019-20, the fund fell significantly short of the requirement.

The problem and its source

•  A key source of the problem is that the 2017 Act guaranteed a tax growth rate of 14%, which is unachievable this year.
• The 14% target was too ambitious to start with.
• Given the government’s inflation target at 4%, this implied a real GDP growth plus tax buoyancy of 9%.
• But, the Central government is constitutionally bound to compensate States for loss of revenue for five years.

Solution to the problem

1) The Constitution could be amended to reduce the period of guarantee to three years thus ending June 2020.

• But most States would be reluctant to agree to this proposal.
• It could also be seen as going back on the promise made to States.

2) The Central government could fund this shortfall from its own revenue.

•  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.

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.

• 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.

Consider the question “What were the reasons for making provisions under GST for paying the states compensation for tax revenue shortfall? What are the implications of the provision for the Central government?”

Conclusion

The Constitution makes it obligatory for the Centre to make up for shortfall by the States. The cess collected will not be sufficient for this purpose. The GST Council, which is a constitutional body with representation of the Centre and all the States, should find a practical solution.

B2BASICS

Source: https://www.thehindu.com/opinion/op-ed/making-up-for-shortfalls-in-gst-collection/article32319744.ece

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