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Tuesday, July 07, 2020

As GST enters fourth year, biggest challenge would be to devise ways to compensate the states

As GST enters its fourth year, Covid has hit collections. It is time to take measures to prevent the states from slipping into a serious financial crisis. These measures will not only define the future of GST but also the course of the unique cooperative federalism that it has ushered in the country.

Written by Sushil Kumar Modi | Updated: July 1, 2020 9:22:46 am
gst, goods and service tax, coronavirus, corona imoact on GST collection, covid-19 impact, coronavirus news, coronavirus impact on economy, Despite the diversity that GST has had to contend with, it has been a remarkable success as a tax in the first two years. (File Photo)

GST faces its toughest test as it enters its fourth year. The upcoming challenge to GST, however, does not stem from its design or structure or the way it has been run. It is up against a pandemic that has wreaked havoc on the global economy and India is no exception.

Despite the diversity that GST has had to contend with, it has been a remarkable success as a tax in the first two years. Faced with an unusually high benchmark of 14 per cent CAGR, GST was very productive in the first two years. The base year revenue in 2015-16 stood at around Rs 8 lakh crore and for the nine months of 2017-18 that GST was operational, the benchmark stood at Rs 7,79,760 crore (at 14 per cent CAGR from 2015-16). As against this, the actual GST revenue stood at Rs 7,40,650 crore, which is 95 per cent of a very tall target. 2018-19 was even better with an actual collection of Rs 11,77,368 crore (99.34 per cent of the benchmarked collection).

However, with the economy beginning to slow down in 2019-20, GST could not remain insulated. Barring April 2019, no other month witnessed double-digit growth over the last year, with September, October and March clocking negative figures. The average growth rate during May-August 2019 was 5.4 per cent, which turned negative in the subsequent two months. With alarm bells ringing, the tax administrations tightened the belt which contributed to the 8.4 per cent growth during the three months ending February 2020. And then the pandemic hit and collections tumbled by more than 8 per cent in March.

As we head into 2020-21, the toughest challenge for the GST Council would be to devise ways to compensate the states. The usual compensation cycle got delayed and the situation is not likely to improve anytime soon with the collection for the first two months of the current fiscal at just 46 per cent of 2019-20 levels.

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The pandemic struck just as the economy seemed to be looking up, which has led to all reform measures being put on hold. The new return system, rate rationalisations, measures to improve compliance and compliance verifications have all been held back, which has further dented revenue prospects.

The biggest challenge is the possibility of a huge deficit in the compensation account. The 14 per cent CAGR formula would lead to a situation where the protected revenue of the states would rise by about 92 per cent from the base year figures and even a 20 per cent drop from last year’s figures would mean that the accruals to the states would be just above their base year revenue. In this scenario, the compensation requirement would be only a little less than 50 per cent of the actual protected revenue for 2020-21. To put this in perspective, the actual compensation cess collection has never exceeded 20 per cent of the total revenue accrual to the states.

It is time to take measures to prevent the states from slipping into a serious financial crisis. These measures will not only define the future of GST but also the course of the unique cooperative federalism that it has ushered in the country.

Of late, there has been a lot of speculation on the subject and most of it has centred around some kind of borrowing. However, borrowing is not the solution to a crisis of this nature, particularly in view of the fact that the financial impact of COVID-19 defies quantification and more so in view of the assured 14 per cent CAGR guarantee to the states. Many complex issues crop up in the context of borrowings. For instance, how and when will it be paid back. If, as suggested, the compensation period was to be extended beyond 2021-22 and the cess during the extended period used to repay the loan, will it not mean eating into future revenue streams of both the Union and the states. It would simply be deferring the crisis instead of really solving it.

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Alternatively, it is being urged that the Centre may borrow long-term to finance the compensation. This would give the Centre enough breathing space and the situation would ease in the really long-term, casting little burden on the Centre’s finances. This idea too is not worth pursuing since there are borrowing limits and the Centre is as much bound by fiscal responsibility. Another variant suggests that the Council may borrow on the Centre’s guarantee. In my view, the Council is probably not an entity that can undertake any such venture.

This leaves us with little option but to rejig the GST rates. I strongly feel that this is not the time to tinker with the rates. But the idea must be debated when the worst is behind us.

GST was introduced with rates about 20 per cent lower than the effective tax burden (all existing central and state levies and the cascading effect). This rate has been further lowered, mostly intermittently, but majorly on two occasions — in November 2017 and July 2018. With a tax base of around Rs 60 lakh crore, a 1 per cent increase in the tax rates would yield additional revenue of Rs 60,000 crore.

Another idea that may be considered along with the rate hike, or even independently, is re-arranging the GST rate structure wherein 60 per cent or 65 per cent of the total tax on a commodity is the state component and the remaining is the central component. For instance, the 18 per cent GST rate could be 11 per cent SGST and 7 per cent CGST or some such combination. Historically, too, with the major cascading built into the states’ VAT rates, the states’ tax rates were higher than of the Centre. These adjustments in the GST rates would yield additional revenue to the states, thereby bringing down the compensation burden.

This article first appeared in the print edition on July 1, 2020 under the title “Putting reform to the test”. The writer is Deputy Chief Minister, Bihar

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