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Explained: The issues in GST compensation

GST compensation payments to states are pending since April. At the GST Council meeting on Thursday, the Centre suggested two options for borrowing by states to bridge shortfall. But many states are unconvinced.

Written by Aanchal Magazine | New Delhi |
Updated: September 1, 2020 9:53:37 am
Union Finance Minister Nirmala Sitharaman on Thursday referred to the Covid-19 outbreak as an “act of God” that would result in a contraction of the economy in the current fiscal.

With Centre-state friction over pending compensation payments under the Goods and Services Tax (GST) taking a new turn in the 41st GST Council meeting on Thursday, strain on the finances of states is likely to continue in the near term. Several states have opposed the two options to borrow that were proposed in the meeting as a way to bridge the revenue shortfall.

GST compensation payments to states have been pending since April, with the pending amount for April-July estimated at Rs 1.5 lakh crore. The GST compensation requirement is estimated to be around Rs 3 lakh crore this year, while the cess collection is expected to be around Rs 65,000 crore – an estimated compensation shortfall of Rs 2.35 lakh crore.

What was discussed at the meeting?

The legal opinion on borrowing was discussed. The opinion of the Attorney General of India was cited to buttress the argument that GST compensation has to be paid for the transition period from July 2017 to June 2022, but the compensation gap cannot be bridged using the Consolidated Fund of India. The AG has suggested the compensation cess levy can be extended beyond five years to meet the shortfall, Finance Secretary Ajay Bhushan Pandey said.

State Finance Ministers, barring a few including those of Assam and Goa, pressed for borrowing by the Centre to bridge the revenue gap. Towards the end of the meeting, the Centre offered two options.

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The first was a special window to states, in consultation with the RBI, to borrow the projected GST shortfall of Rs 97,000 crore, and an amount that can be repaid after five years of GST, ending June 2022, from the compensation cess fund. A 0.5% relaxation in the borrowing limit under The Fiscal Responsibility and Budget Management (FRBM) Act would be provided, delinked from the conditions announced earlier as part of the pandemic package linked to the implementation of reform measures such as universalisation of ‘One Nation One Ration Card’, ease of doing business, power distribution, and augmentation of urban local body revenues.

The second option was to borrow the entire projected shortfall of Rs 2.35 lakh crore – both on account of faltering GST collections and the expected shortfall due to the pandemic – facilitated by the RBI. No FRBM relaxation has been mentioned for this option so far.

Also read | Govt blames Covid, but payment stalled year ago


What are the views of the states on these?

Five states and Union Territories – Kerala, Punjab, West Bengal, Puducherry and Delhi – have voiced their concerns over the proposals.

KERALA: Finance Minister Thomas Isaac said enforcing a cut in compensation and bringing in a distinction between GST and Covid-related revenue loss is unconstitutional. He has said that the states’ FRBM limit should be raised by at least 1.5 percentage points if the entire Rs 2.35 lakh crore has to be borrowed.

PUNJAB: Finance Minister Manpreet Singh Badal has said these options were thrust upon the states, and the borrowing would translate into “mortgaging of the future to live for the present”.


DELHI: Deputy CM Manish Sisodia has said the Centre’s refusal to pay states is the “biggest betrayal” in the history of federalism in India, and has expressed concerns about Delhi’s inability to borrow via the RBI to bridge the compensation gap, given its status of a UT with state legislature.

WEST BENGAL: Finance Minister Amit Mitra said borrowing by states will increase their debt servicing liability, and any other interpretation of the compensation-related Section 18 of The Constitution (One Hundred and First Amendment) Act is unjustifiable. Section 18 of the amendment says Parliament shall, on the recommendation of the GST Council, provide for compensation to states for the loss of revenue arising out of implementation of the GST for five years.

States have asked the Centre for details of the two options. They will then have seven working days to get back with their views.

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. Union Finance Minister Nirmala Sitharaman on Thursday referred to the Covid-19 outbreak as an “act of God” that would result in a contraction of the economy in the current fiscal.

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When did the issue of compensation to states arise, and how did it evolve?

Shortfall issues surfaced almost a year ago when payments due for August-September 2019 were delayed. Since then, all subsequent payouts have seen cascading delays.

The economic slowdown, which has been on for almost three years now, began to impact GST revenue collections in August 2019. The Centre first admitted to problems on compensation payment in the 37th GST Council meeting in Goa last September – it said the amount of cess available in the compensation fund at the end of February “shall fall short for payment of compensation for loss of revenue till the bi-monthly period of December-January”.


On November 27, 2019, the GST Council wrote to states that the GST and compensation cess collections in the previous few months had become a “matter of concern”, and that compensation requirements were “unlikely to be met”.

GST compensation payments had started getting delayed by then. Many state FMs had begun to express concerns over having to repeatedly ask for their share of revenues. The GST compensation payment of Rs 35,298 crore for August-September 2019, which was due in October, was paid in December. The Centre released another Rs 34,053 crore in two instalments in February 2020 and April 2020 as compensation for October-November 2019.

In June this year, Rs 36,400 crore was released as GST compensation for December-February, and the balance Rs 13,806 crore for March was released in July, taking the total compensation payout for FY20 to Rs 1.65 lakh crore.

Under The GST (Compensation to States) Act, 2017, states are guaranteed compensation for loss of revenue on account of implementation of GST for a transition period of five years (2017-22). The compensation is calculated based on the difference between the states’ current GST revenue and the protected revenue after estimating an annualised 14% growth rate from the base year of 2015-16.

The high rate of 14%, which has compounded since 2015-16, has been seen as delinked from economic realities. Chairing the first few meetings of the GST Council, then Finance Minister Arun Jaitley had proposed a revenue growth rate of 10.6% (the average all-India growth rate in the three years preceding 2015-16). Council meeting records show the suggestion of 14% revenue growth was accepted “in the spirit of compromise”.

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First published on: 29-08-2020 at 04:00:19 am
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