The economic slowdown is taking a toll not only on the Central government finances, but on state finances as well. Particularly worrying is the lower than expected GST collections. State governments have reportedly been told that the compensation requirements of states, owing to the shortfalls in GST collections, are “unlikely to be met” from the compensation cess being collected. This grim prognosis comes after the Centre delayed compensating states for the shortfall in GST revenues for August-September, which were due in October, resulting in some states issuing a statement raising their concerns. Coming at a time when public expenditure has been driving growth, this uncertainty surrounding revenues may end up constraining state spending going forward. And as states account for a greater share of general government (Centre and states) expenditure, any cut-backs will further intensify the slowdown.
As per the GST Act, states have been guaranteed compensation in the event of their revenue growth falling below 14 per cent (base 2015-16) for a five-year period ending in 2022. If the collections from the compensation cess are unable to fully meet the shortfall in state GST revenues in a particular year, then there is a provision which allows for clawing back the compensation paid, over and above what was required in the previous year, to settle the excess shortfall. Beyond that, whether and how the Centre manages to fulfill its obligation of ensuring that states achieve 14 per cent revenue growth is uncertain. Then there is the issue of extending the compensation period for states beyond 2022. With growth slowing down, and with states’ own revenue, including GST, coming under pressure, there is a growing clamour for extending it to 2025. While the Centre is yet to clearly spell out its position on the issue, a study commissioned by the 15th Finance Commission has estimated that even if tax buoyancy rises, states will continue to face a shortfall, even after 2022, and would therefore need to be compensated if their revenue growth is to be maintained.
State governments have now been asked to share their views on proposals regarding a review of items under exemption, GST and compensation cess rates, compliance and revenue augmenting measures, which are likely to be discussed at the next council meeting. At the current juncture, a knee jerk reaction to slowing revenues is best avoided. Instead, the long-term approach should be to gradually reduce the items in the highest tax slab, prune the list of exempt items, and move towards reducing the number of tax slabs. Further, the council must also look to improving the ease of filing and other measures to boost compliance levels, and plug more gaps in the GST architecture.