The issue of compensating states for the shortfall in their goods and services tax (GST) collections has been contentious. Several states have argued that the Centre has been delaying the compensation owed to them due to lower collections through the compensation cess route. To address this issue, on Monday, the Central government announced that it had released Rs 13,806 crore to states for the compensation owed to them for March 2020, also noting that the entire amount upto 2019-20 had been released. According to the data, as against cess collections of Rs 95,444 crore, the total compensation paid to states stands at a staggering Rs 1.65 lakh crore in 2019-20, underlining the extent of slippage in state GST collections in 2019-20. The situation is likely to worsen this year. With economic activity likely to remain well below pre-COVID levels, state GST collections will fall well short of expectations. Collections through the compensation cess will not be enough to offset the shortfall in states’ revenues as measured against their protected revenue growth. As income from GST accounts for a significant share of state revenue, this needs attending to.
The GST Council, in which the Centre effectively has a veto, is expected to meet shortly to deliberate on this issue. While the rationale for assuring states a fixed growth rate of 14 per cent for their GST collections can be debated — linking it to nominal GDP growth may have been a better alternative — not abiding by its promise is certainly not in line with the spirit of cooperative federalism espoused by the Centre. It will set a bad precedent. The challenge, therefore, facing the GST council is two-fold: First, how to compensate states for the greater than expected shortfall this year, and second, whether or not the compensation cess should be extended beyond the five-year period that was originally agreed upon.
Several options have been debated. First, market borrowing has been discussed as a possible way out of this quagmire. However, its legality will need to be examined. Hiking tax rates, or the compensation cess, may not be appropriate at the current juncture. With states also likely to witness a significant shortfall in tax devolution this year, as compared to the budget estimates, further shortfalls in their revenue, despite the additional borrowing space, will severely restrict their spending. Given that states are at the forefront of fighting the COVID pandemic, the council must ensure adequate flow of resources to them, and reduce the uncertainty in state finances.