The distribution of GST proceeds has triggered a new flashpoint in Centre-state relations amid fresh indications of delayed compensation payments and dues to the states.
While the Centre on Monday released Rs 13,806 crore to the states for March 2020, wrapping up the full payout for FY20 at Rs 1.65 lakh crore, compensation payments for this financial year since April remain pending. Key Finance Ministry officials are reported to have briefed the Standing Committee on Finance Tuesday about the Centre’s inability to pay states in the near future.
Punjab has responded by flagging the need for “timely GST payments”, stating that four months of pending dues are equivalent to two months of salaries bills of the state. Kerala has described the reported statement by Ministry officials as a “brazen betrayal of federal trust”. West Bengal Chief Minister Mamata Banerjee wrote to Prime Minister Narendra Modi earlier this week, urging the Centre to release GST compensation worth Rs 4,135 crore for April and May.
Why has GST compensation been an issue?
The concerns started surfacing in October last year, when the payments to states got delayed as GST revenues came in lower than expected. The Covid-19 pandemic has deepened the economic slowdown and impacted revenues, with GST collections recording a 41% decline in the April-June quarter.
As the amount to be paid to states started rising with a compounded 14% rate even as compensation collections remained around the same level for two consecutive years, the high 14% rate has been viewed as delinked from economic realities. For instance, in the ongoing financial year, the SGST (state GST) revenue for June has been Rs 23,970 crore, while monthly protected revenue is Rs 63,706 crore, leaving a gap of Rs 39,736 crore (not taking into account settlement of IGST, the tax levied on all inter-state supplies of goods and services). Only Rs 14,675 crore has been collected as compensation cess in April-June, including Rs 7,665 crore in June.
The Centre has cleared compensation dues for FY20 of Rs 1.65 lakh crore, while the collection under the compensation cess fund was only Rs 95,444 crore, implying the payments were over 70% higher than the collection.
The gap was partly bridged by money from the compensation fund that had remained unutilised in the first two years of GST, along with Rs 33,412 crore that was ploughed back from Consolidated Fund of India to the compensation fund. (This was after the settlement of IGST dues had showed an excess apportionment by the Centre in FY18, due to the ad-hoc method of IGST settlement being followed in the first few months after the GST rollout in July 2017.)
Now, compensation payments to states are pending since April.
How much is transferred to the compensation fund?
In the Budget for 2020-21, while announcing the transfer of balances due from the collections for 2016-17 and 2017-18 in two instalments to the GST Compensation Fund, Finance Minister Nirmala Sitharaman had said that henceforth, transfers to the fund would be “limited only to collection by way of GST compensation cess”.
Vijay Kelkar, former Finance Secretary and 13th Finance Commission Chairman, and Pune International Centre’s Senior Fellow V Bhaskar co-authored a recent paper that questioned this proposition. “While the Centre’s position appears legally tenable, it does not appear ethically defensible… its decision to restrict transfer to the Fund only to compensation cess collections seems more a fiscal aspiration than a legal compulsion. Section 10(1) of the Act allows for ‘other amounts’ also to be credited to the Compensation fund with the approval of the GST Council,” they wrote.
At present, the cess levied on sin and luxury goods such as tobacco and automobiles flows into the compensation fund. In the GST Council meetings in early 2017, states had suggested alternative sources of revenue for the compensation fund in case of a shortfall, with borrowing among the options. Minutes of the 8th GST Council meeting state: “The Hon’ble Chairperson (then Finance Minister Arun Jaitley) that compensation to States shall be paid for 5 years in full within the stipulated period of 5 years and, in case the amount in the GST Compensation Fund fell short of the compensation payable in any bimonthly period, the GST Council shall decide the mode of raising additional resources including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years.”
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What are the options for meeting the compensation gap?
Market borrowing has been discussed in the GST Council as one of the possible solutions, although the legality of the Council in borrowing will need to be explored. There is also an emerging view among states in favour of hiking the GST rates or restructuring the GST slabs. The states, however, agree that tinkering with the rate structure needs to be done only after the effects of the pandemic-induced slowdown wear off.
There are differing views among states on the Council itself resorting to market borrowing. While Kerala backs such a move and Bihar opposes it, all states are unanimous on sticking to the 14% assured rate for compensation. Some states are also of the view that the compensation period should be extended beyond the stated period of five years.
Hiking the cess rate or lowering of the guaranteed compensation rate have featured in the discussions of GST Council meetings, but states are not in favour of either option. As per estimates shared by Bihar Deputy Chief Minister Sushil Kumar Modi, even if revenue collections in 2020-21 are projected at 65% of the revenues collected in 2019-20, there would be a revenue gap of Rs 2,67,000 crore for states. Even if a 5% cess is levied on high-end luxury goods, which form about 10% of the overall GST base, it would only yield about Rs 22,000-25,000 crore per annum, he had earlier said.
In their paper, Kelkar and Rao have said the Centre should promptly respond to the demand from states to pay them overdue compensation cess by borrowing from the market. “Though it does not appear to be legally liable, it has a moral imperative to do so, even if the guaranteed rate of revenue of 14% is inordinately high in the present COVID led economic downturn,” the paper said, adding that a restructuring of the GST model should be considered if the losses for states continue.
When are these issues being taken up next?
In the previous GST Council meeting in June, it was decided that the next meeting would be convened in July and will be a one-agenda meeting, focusing only on compensation. The meeting is yet to be convened.
Kerala Finance Minister Thomas Isaac on Wednesday called for an immediate Council meeting.
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