The Goods and Services Tax (GST) Council is likely to discuss at his meeting on Thursday a market borrowing mechanism to help states leverage recently enhanced borrowing limits to compensate them for revenue shortfalls and debts thus raised to be eventually repaid from the compensation cess fund, two officials said.
Other options like levying cess on more items, increasing cess rates on existing products or raising overall GST rates to raise revenue appears difficult at a time when demand is subdued and the economy is badly hit by Covid-19 pandemic, the officials added requesting anonymity.
The special GST Council meeting has been convened to discuss how to compensate states for their revenue shortfalls when the economy is facing headwinds and the compensation cess kitty for 2020-21 is almost empty, the officials said.
The pandemic and a 68-day nationwide lockdown to check its spread from March 25 hit the country’s economic growth, which had already slowed. India’s Gross Domestic Product (GDP) slowed to 4.2% in fiscal 2019-20, the lowest in 11 years.
The GST law assures states a 14% increase in their annual revenue for five years from July 1, 2020. It also guarantees them that their revenue shortfall, if any, would be addressed through the compensation cess levied on luxury goods and sin products like liquor, cigarettes, aerated water, automobiles, coal and tobacco products.
As cess collection fell sharply due to subdued business activities, states could not be paid compensation on time. According to official data, the last tranche of the GST compensation worth Rs 13,806 crore for 2019-20 was paid towards the end of July. So far, states have been paid Rs 1,65,302 crore GST compensation for 2019-20 against Rs 95,444 crore cess collection.
“With promised 14% year-on-year revenue growth, the gap is expected to be unmanageable this financial year without borrowing from the market,” one of the officials said. The compensation requirement for 2020-21 is expected to exceed Rs 1.88 lakh crore even if the GST collection in 2020-21 remains at the same level as last financial year, he said.
Some states have a misconception that it is the commitment of the Centre to compensate states and therefore it should borrow the money to pay to states and union territories, the officials said. In fact, paying compensation is the collective commitment of both the Union and state governments, and the GST Council is the apex body to take a decision on this matter, they added.
“The GST law is clear that states will be compensated for their revenue shortfall only from the compensation cess fund. There is no legal provision that the compensation money will come either from the Consolidated Fund of India or the Union government will borrow from the market. Therefore, this matter will be resolved at the GST Council on the principle of collective responsibility. Ideally, states should leverage their enhanced borrowing limits,” a second official said.
To give fiscal space to states in this time of crisis, the Centre raised their borrowing limits. Announcing the last tranche of Rs 20 lakh crore Aatmanirbhar Bharat Abhiyan (Self-Reliant India campaign) on May 17, Union finance minister Nirmala Sitharaman said the Centre had accepted the demand of states to raise their borrowing limit from 3% of their respective gross state domestic product to 5%. She said it would give them additional resources of Rs 4.28 lakh crore during the crisis.
Experts say the shortfall in compensation cess collection is mainly because of unforeseen circumstances as the architects of the GST regime could not foresee a pandemic-like Covid-19 that would batter the economy. India is expected to report its April-June GDP numbers by the end of this month. Economists expect its economy to contract by at least 5% this year especially because of the hard lockdown for two months of the quarter–April and May.
Archit Gupta, founder and chief executive officer of the financial technology platform ClearTax, said: “Increasing state borrowing seems to be an option to fund the revenue shortfall for states. The other option suggested was to allow the GST Council to borrow, and repay from cess collection in future years.”
He said these measures are short term. “…states need to become more fiscally responsible, reduce their debt and make attempts to become fiscally self-reliant to a large extent.”
Pratik Jain, partner and leader of the indirect tax practice at PwC India, said it is evident that cess collected is not enough to compensate the states, particularly in current economic slowdown due to the pandemic. “However, at this point, neither increasing the rate of cess nor the ambit look like feasible options.”
Jain said the Centre will need to negotiate the quantum of compensation, possibly by reducing the 14% annual increment and increasing the period of compensation beyond five years as initially envisaged. “In the long term, we will have to find ways for the states to be more economically independent and enhance the tax base.”