Over the last few weeks, there has been a heated discussion between the central and state governments on goods and services tax (GST) compensation. The Centre had assured states of compensation for any shortfall in tax collections till 2022. Mint explores the issue.
Why are tax revenues under a lot of stress?
Tax revenues are a function of economic activity. Higher activity growth means higher revenue, while lower growth implies lower revenue. Under the present circumstance, in which nearly 65% of the economic sectors were shut during the pandemic, there was limited activity. Consequently, tax revenues were adversely affected. The impact has been significant on both direct taxes such as income and corporate tax, as well as indirect taxes such as customs and goods and services tax. However, as economic activity normalizes, tax collections are likely to improve and get back to the pre-pandemic levels.
What about the GST shortfall of states?
Several states were concerned about tax shortfalls because of the implementation of GST. This issue was resolved by the central government guaranteeing that the states would be compensated in the event of any tax revenue shortfall. Consequently, the compensation cess was levied and any compensation was to be paid from the revenue generated through the compensation cess. However, the present circumstance is a different one as the revenue shortfall is not because of the implementation of GST. Rather, it is because of a black swan event, which is the coronavirus outbreak.
Aren’t states guaranteed of compensation in any case?
States argue that the Centre is legally and ethically bound to provide them with GST compensation as promised. The Centre recognizes the commitment made towards compensation for shortfall as a result of GST implementation. However, the pandemic has significantly impacted tax collections putting a severe constraint on the central government finances.
What about proposals made by the Centre?
The central government has proposed two solutions to the states. The first is to compensate only for the tax shortfall arising due to GST implementation and allowing states to borrow money while the interest on borrowings will be paid using the revenue from compensation cess. The other is to allow states to directly borrow the entire tax shortfall, but the interest in such a case will be paid for by the states’ revenue, while the Centre would ensure a lower rate of interest. The states have rejected both the proposals.
What does this mean for India’s citizens?
Policy prescriptions during downturns include a Keynesian stimulus in the form of high expenditure by the governments. Hence, providing states with money to spend is critical for recovery as state expenditure has a higher impact on revival. However, with states rejecting proposals, the GST Council will have to find an alternative way to compensate the states. In the interim, states may have to resort to raising revenue via disinvestment in state PSUs and monetization of assets.
Karan Bhasin is a policy researcher.