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Insights into Editorial: The issues in GST compensation



With Centre-state friction over pending compensation payments under the Goods and Services Tax (GST) taking a new turn in the 41st GST Council meeting strain on the finances of states is likely to continue in the near term.

Several states have opposed the two options to borrow that were proposed in the meeting as a way to bridge the revenue shortfall.

GST compensation payments to states have been pending since April, with the pending amount for April-July estimated at Rs 1.5 lakh crore.

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.

Background: centre to address this issue of revenue loss:

Centre promised to reimburse the shortfall in tax revenues for 5 years to the states, which was to be funded by GST Compensation Cess.

The tax year on year growth for the states, upon the base, was promised as 14%.

Now, the Centre is abdicating its responsibility of making up for the shortfall in 14% growth in GST revenues to the states, which makes the position of states perilous.

What was discussed at the meeting?

The opinion of the Attorney General of India was cited to buttress the argument that GST compensation has to be paid for the transition period from July 2017 to June 2022, but the compensation gap cannot be bridged using the Consolidated Fund of India.

The AG has suggested the compensation cess levy can be extended beyond five years to meet the shortfall.

Towards the end of the meeting, the Centre offered two options.

The first was a special window to states, in consultation with the RBI, to borrow the projected GST shortfall of Rs 97,000 crore, and an amount that can be repaid after five years of GST, ending June 2022, from the compensation cess fund.

A 0.5% relaxation in the borrowing limit under The Fiscal Responsibility and Budget Management (FRBM) Act would be provided, delinked from the conditions announced earlier as part of the pandemic package linked to the implementation of reform measures such as universalisation of ‘One Nation One Ration Card’, ease of doing business, power distribution, and augmentation of urban local body revenues.

The second option was to borrow the entire projected shortfall of Rs 2.35 lakh crore – both on account of faltering GST collections and the expected shortfall due to the pandemic – facilitated by the RBI.

No FRBM relaxation has been mentioned for this option so far.

What are the views of the states on these?

  1. Five states and Union Territories: Kerala, Punjab, West Bengal, Puducherry and Delhi have voiced their concerns over the proposals.
  2. Finance Minister of Kerala said enforcing a cut in compensation and bringing in a distinction between GST and Covid-related revenue loss is unconstitutional. He has said that the states’ FRBM limit should be raised by at least 1.5 percentage points if the entire Rs 2.35 lakh crore has to be borrowed.
  3. Finance Minister of Punjab said these options were thrust upon the states, and the borrowing would translate into “mortgaging of the future to live for the present”.
  4. States have asked the Centre for details of the two options. They will then have seven working days to get back with their views.
  5. However, reflecting the original divide at the time of the introduction of GST, poorer, consumption states such as Bihar or West Bengal would be less eager to change this system which still benefits them relatively.
  6. To add to this is the fact that India is expecting a long and protracted economic slowdown, which means tax collection would be poor, no matter which regime is in place.

What is the significance of GST for states?

  1. States no longer possess taxation rights after most taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under GST.
  2. GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.
  3. Finances of over a dozen states are under severe strain, resulting in delays in salary payments and sharp cuts in capital expenditure outlays amid the pandemic-induced lockdowns and the need to spend on healthcare.
  4. The Finance Secretary said GST collections had been severely impacted by the
  5. Revenues are expected to be hit further; the economy is projected to record a recession this year.
  6. Union Finance Minister referred to the Covid-19 outbreak as an “act of God” that would result in a contraction of the economy in the current fiscal.

The GST (Compensation to States) Act, 2017:

Note that under the GST (Compensation to States) Act, 2017, Centre can provide compensation to states only through the money available in the Compensation Fund.

The Union Finance Minister, in her budget speech in February 2020, clarified that transfers to the Fund would be limited only to collections of the GST compensation cess.

Despite a shortfall of money in the Compensation Fund, the Centre is constitutionally obligated to meet states’ compensation requirement for a period of five years.

Measures for Way Forward:

  1. Various measures have been suggested to address the issue of shortfall in the Fund, either by reducing the compensation payable to states (which would require Parliament to amend the Act following GST Council’s recommendation) or by supplementing the funds available with the Centre for providing compensation to states.
  2. The Act allows the GST Council to recommend other funding mechanisms/ amounts for credit into the Compensation Fund.
  3. For example, one of the measures proposed for meeting the shortfall involves Centre using market borrowings to pay compensation to states, with the idea that these borrowings will be repaid with the help of future cess collections.
  4. To enable this, the GST Council may recommend to the Centre that the compensation cess be levied for a period beyond five years, i.e. post-June 2022.


GST is a crucial and long-term structural reform which can address the fiscal needs of the future, strike the right and desired balance to achieve co-operative federalism and also lead to enhanced economic growth.

As stated by the Secretary of the GST Council in the tenth meeting, the central government could raise resources by other means for compensation and this could then be recouped by continuing the cess beyond five years.

As equal representatives of the citizens State governments expected the Centre to demonstrate empathy and provide them relief through the Consolidated Fund of India.

The current design and implementation have failed to deliver on that promise. A new grand bargain is needed.