GST compensation: Asking States to borrow isn’t the right solution

Mohan R Lavi | Updated on August 31, 2020

If GST is truly a tax that represents the spirit of federalism, the Centre should come out with a proper plan to compensate State governments

Three years ago, if State governments had the premonition that embracing GST would lead them to a situation wherein they would have to borrow to make good revenue shortfalls, they would have opted out of one-tax regime. Asking States to borrow is precisely what has been recommended by the GST Council in its latest meeting.

Some State governments have protested against this proposal and are also bracing themselves to take this all the way to the Supreme Court.

Revenue shortfall

The GST Council split the revenue shortfall into two categories — due to reduced GST revenues and due to Covid-19. The Council also gave State Governments two options — a special window, in consultation with the RBI, to borrow the projected GST shortfall of ₹97,000 crore, and an amount that can be repaid after five years of GST, ending June 2022, from the compensation cess fund aided by a 0.5 per cent relaxation in the borrowing limit under the Fiscal Responsibility and Budget Management (FRBM) Act.

The second option is to borrow the entire projected shortfall of ₹2.35-lakh-crore — both on account of faltering GST collections and the expected shortfall due to the pandemic — facilitated by the RBI. While the entire world is increasingly being convinced that the pandemic is due to an act of indiscretion on the part of China, the Finance Minister termed it an ‘act of God’.

The reason for asking State governments to resort to borrowing is because of a legal opinion given by the Attorney General of India that the period of payment of compensation can be extended beyond June 2022 but the Consolidated Fund of India cannot be used to bridge the gap. It’s almost a year since the GST Council knew that there would be persistent shortfalls in the compensation payable to State governments — but no concrete action was taken as everyone thought that things would self-correct over a period of time. But, then, Covid struck.

The economy is down, collections are not improving and evasion is rampant. Yet, the GST Council cannot run away from the problem and leave State governments holding the baby.

If GST is truly a tax that represents the spirit of federalism, the Centre should come out with a proper plan to compensate State governments. In times like this, the question is not who should borrow but who has a better credit rating to borrow coupled with multiple options. Undoubtedly, the Central Government has a better credit rating and options to borrow, including international agencies and financial institutions. The Centre also has the luxury of having a central bank with a strong balance sheet. The kerfuffle over GST compensation has ensured that there are a couple of certainties in the near future. Liquor for human consumption, fuel and stamp duty will not come under the purview of GST for some more years — individual States would ensure that, citing the bad experience thus far. As a result, what we would have will not be an ideal GST but a “jugaad GST” — which seems an apt solution for a diverse country like India.

The second certainty is that GST battles of the future are going to be fought not on economic/taxation grounds but on political grounds. This could derail some of the GST provisions since States would tend to resist them due to political differences.

The GST Council should quickly think of a workable solution to compensate States.

The writer is a chartered accountant

Published on August 31, 2020

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