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In what appears to be a relief for the states, the Centre has said it will borrow up to Rs 1.1 trillion, which is the estimated revenue shortfall on account of implementing goods and services tax. The centre will then lend the money to the states under a special window. The extra fund raising was reflected in the borrowing calendar released by the RBI and the finance ministry. The Centre borrowing on behalf of states is likely to ensure that a single rate of borrowing is charged and this would also be easy to administer.

GST compensation:

  • The Constitution (One Hundred and First Amendment) Act, 2016, was the law which created the mechanism for levying a nationwide GST.
  • Written into this law was a provision to compensate the States for loss of revenue arising out of implementation of the GST. The adoption of the GST was made possible by the States ceding almost all their powers to impose local-level indirect taxes and agreeing to let the prevailing multiplicity of imposts be subsumed under the GST.
  • While the States would receive the SGST (State GST) component of the GST, and a share of the IGST (Integrated GST), it was agreed that revenue shortfalls arising from the transition to the new indirect taxes regime would be made good from a pooled GST Compensation Fund for a period of five years that is set to end in 2022.
  • This corpus in turn is funded through a compensation cess that is levied on so-called ‘demerit’ goods.
  • The computation of the shortfall — the mechanism for which is spelt out in Section 7 of the GST (Compensation to States) Act, 2017 — is done annually by projecting a revenue assumption based on 14% compounded growth from the base year’s (2015-2016) revenue and calculating the difference between that figure and the actual GST collections in that year.
  • For the 2020-21 fiscal year, the revenue shortfall has been anticipated at ₹3 lakh crore, with the Compensation Fund expected to have only about ₹65,000 crore through cess accruals and balance to pay the compensation to the States.

How are the borrowing options supposed to work?

  • Asserting that it is under no obligation to make good any shortfall in the GST and that it is up to the GST Council to devise a solution, the Union government has proposed that the States borrow directly from the market by issuing debt under a special window coordinated by the Ministry of Finance.
  • The Centre has also contended that of the projected shortfall of about ₹2.35 lakh crore, only ₹97,000 crore is the deficit arising out of GST implementation, with the balance ₹1.38 lakh crore attributable to an ‘act of God’ (the COVID-19 pandemic) that is independent of implementation of the new indirect tax regime.
  • Accordingly, Option 1 entails the States selling debt securities in the market to raise the ₹97,000 crore. The Centre will “endeavour” to keep the interest cost on these borrowings “at or close to” the yield on G-Sec (bonds issued by the Government of India), and in the event of the cost being higher, bear a part of the difference through a subsidy. This additional borrowing by the States will not be accounted for as a part of the State’s debt for purposes of its overall debt calculation, and the repayment of the principal and interest on these borrowings will be done from the Compensation Fund by extending the period of cess collections beyond 2022.
  • Under Option 2, the States can sell debt in the market to raise the entire ₹2.35 lakh crore shortfall but with the terms of the borrowing being far less favourable. Crucially, here the interest cost would have to be borne by them with only the principal being serviced by the Compensation Fund.

Centre decides to borrow:

  • In what appears to be a relief for the states, the Centre has said it will borrow up to Rs 1.1 trillion, which is the estimated revenue shortfall on account of implementing goods and services tax (GST), and lend the states under the special window.
  • The clarification comes four days after the GST Council meeting ended in an impasse over the compensation mechanism and the dissenting states have been exploring legal options, including going to the Supreme Court.
  • It is positive step because centre’s borrowing interest rate is lower by 50-60 basis points.
  • The ministry said it would not have any impact on the fiscal deficit of the Centre and the amounts will be shown as capital receipts of the state governments and as part of financing their respective fiscal deficits.
  • This will avoid differential rates of interest that individual states may be charged for their respective SDLs (state development loans) and will be an administratively easier arrangement.
  • While the Centre had not spelt out the details of the special window, the states have inferred from this that each will have to borrow separately. They were promised full compensation by the Centre for the first five years of GST implementation.
  • Despite a lack of consensus on the issue in the Council meeting, the finance ministry initiated the borrowing process for 21 states that had picked the option of borrowing up to Rs 1.1 trillion. Under this option, the principal and interest will be repaid via compensation cess, which has now been extended beyond June 2022.
  • This is in true federal structure.

What is the significance of GST for states?

  • States no longer possess taxation rights after most taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under GST. GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.
  • 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.
  • The Finance Secretary said GST collections had been severely impacted by the pandemic. Revenues are expected to be hit further; the economy is projected to record a recession this year.

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.

Way Forward:

  • We need to think in true spirit of federalism to resolve this issue in long term as well.
  • 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.
  • States should also become little practical and fragmatic that 14% annual growth rate in revenues is little impractical in post- Covid times, they should not insist on 14% revenue growth for next few years.
  • Need of permanent Fiscal commission like MPC.
  • The Act allows the GST Council to recommend other funding mechanisms/ amounts for credit into the Compensation Fund.
  • 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.
  • 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.
  • Separating debt from monetary management.
  • GST council as a body needs to reclaim its relevance.
  • Local bodies should also start borrowing like Bengaluru and Chennai Municipal corporation.
  • 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.