The Goods and Services Tax (GST) regime was introduced in India in 2017 to streamline the country’s indirect tax structure, replacing a complex system of multiple taxes levied by both the central and state governments. The GST aimed to create a unified market, enhance ease of doing business, and foster economic growth by eliminating cascading effects and ensuring a more efficient tax collection mechanism. However, the transition to GST posed challenges for state governments, particularly in terms of potential revenue losses due to the abolition of various taxes and the introduction of a uniform tax rate across states.
To address the concerns of states regarding revenue losses during the initial years of GST implementation, the Goods and Services Tax (Compensation to States) Act of 2017 was enacted. This legislation guaranteed compensation to states for any revenue shortfall below a certain threshold for a period of five years from the commencement of GST. The compensation was funded through the GST Compensation Fund, which was to be financed by levying a cess on certain luxury and sin goods.
Tag: Indian economy and issues related to planning, mobilization of resources, growth development and employment. Inclusive growth and issues arising from it. Government budgeting.
Decoding the Question:
- In Introduction, start with writing about GST compensation.
- Body
- Explain the rationale behind GST compensation act 2017
- Discuss how Covid-19 impacted the GST compensation fund and gave rise to new federal tensions.
- Try to conclude with suggestions and how to strengthen fiscal federalism.
Answer:
The GST (Compensation to the States) Act 2017 , provides for compensation to the states for loss of revenue arising on account of implementation of the goods and services tax for a period of five years as per section 18 of the Constitution (101st Amendment) Act, 2016. It calls for a compensation by the center to the states upon a 14% or more shortfall of revenue under GST till June 2022.
The rationale behind GST Compensation Act 2017:
- Compensation for manufacturing states: The states like Maharashtra, Gujarat, and Tamil Nadu lost a portion of their revenue as GST is a consumption tax, and thus the tax amount goes to the state of consumption rather than manufacturing state as earlier.
- To meet Revenue Shortfall of States: GST was introduced as one nation one tax by integrating the indirect taxation system of the country. This compensation fund was created through imposing concession cess on demerit goods.
- Creating constitutional liability: The Act created a constitutionally binding agreement between center and state regarding GST compensation.
- Fixed Revenue Growth: The Centre had assured 14% year on year GST revenue growth for 5 years. If such an amount is not available then the Centre will compensate the State for such deficiency.
- Meeting the Actual Revenue Targets of the state: The total compensation payable in any financial year shall be the difference between the projected revenue for any financial year and the actual revenue collected by a state. This is done through the GST compensation corpus fund created for it.
How Covid-19 impacted GST compensation fund and gave rise to new federal tension:
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 crores through cess accruals and balance to pay the compensation to the States.
- Lower tax collection for states: The slide in economic activities due to the imposition of localized lockdowns to deal with the second wave of Covid-19 is likely to further strain the fiscal position of state governments.
- Gap in financing vaccines: While economic activity is slow, the vaccination drive gathers momentum. According to an estimate it can gulp up as much as 30% of the state’s revenues.
- Bypassing of Council: The GST Council would have been expected to provide a forum to discuss and debate solutions to the compensation crisis. Instead, what was seen was that the Union tried to bypass the council.
- States rejected Market Borrowing Mechanism: many states like W. Bengal, Kerala, Punjab, etc. are against market borrowings and asking Centre to fulfill the constitutional obligation. As the GST act and Compensation Act made it clear that the revenue shortfall of states will have to be compensated by the Centre under the agreement.
- Supreme Court’s Intervention: Opposition party ruled states moved to the Supreme Court against Centre’s move to break down constitutional/federal agreement.
- Non-Uniform Impact: Considering that the virus spread and lockdown restrictions have varied across states, the loss across states may not be uniform.
Way Forward:
- It is time for states to accept the realities and agree to a lower level of compensation, ideally linked to the growth rate of the Indian economy in nominal terms.
- States can’t turn blind eye to the aftermath of the pandemic.
- The Union government must also need to lead the country out of its GST impasse by borrowing more from financial markets or directly from RBI.
- The Centre must understand that it is their statutory obligation and they can’t abrogate it.
- States should reciprocate by settling for a more realistic compensation for time being while exploring the options suggested by the Centre.
In this context, the present regime of GST compensation act guaranteeing a revenue growth to the tune of 14% may be unreasonable. Linking it to nominal GDP growth may be a better alternative. The Centre should focus on its constitutional obligation and give States their due share of revenue by borrowing from the market. Therefore, Covid-19 has created federal-economic issues and these issues should be handled in the prudence of constitutional wisdom and the Centre should allow States to raise money by imposing cess in their respective domain.
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