by Aswathi Prakash & Cheerla Kavya
Countries all over the world are grappling with the pandemic and it’s after effects. It has adversely affected economies worldwide. As per the official data released by the Ministry of Statistics and Programme Implementation, the Indian economy contracted by 23.9% in the April-June quarter of this fiscal year. With one of the largest and stringent lockdowns in the world, all economic activities in the country were brought to a standstill. The Indian states, in particular, have been badly hit as health comes under the state list thereby placing them at the forefront fighting the virus. The lockdown had further crunched their revenues as most of the state revenues came from the real estate, petroleum and alcohol sales which came to a halt during the lockdown. It is against this backdrop that the GST compensation row and what it signifies for the fiscal federalism in the country needs to be examined.
Fiscal federalism has evolved as an important pillar of the fiscal relations between the Centre and states and more so now than the initial years of our independence. In independent India, the Planning commission and Finance commission was largely responsible for the federal transfers. They were tasked with the disbursement of funds to the states. The highly centralized structure was deemed important for the circumstances that the country found itself in post-independence. However, a major portion of these transferred funds were “tied [funds]”, constraining the state’s discretion with regard to their expenditure. The Planning commission was dismantled and replaced with the advisory NITI Aayog in 2015. This was seen as a major leap towards redesigning India’s fiscal federalism, as states enjoyed better representation than what they had in the Planning commission. GST is seen as another landmark step towards this end.
GST rollout had come with a lot of promises for the economy. It brought in a comprehensive system of indirect taxation that existed by subsuming the numerous central and state levied taxes into a single ambit. GST was also seen as a progressive step towards furthering the fiscal federalism of India. It is expected to boost the federal fiscal structure by its emphasis on a consensus based approach to decision making and thereby giving states an increased say with regards to indirect taxation in the country. It is this emphasis on a consensus-based functioning that encouraged ex- Union Finance minister Arun Jaitley to opine that the new GST regime would usher in a new era of cooperative federalism, a welcome departure from competitive federalism. However, it cannot be denied that the states lost their autonomy to frame independent tax laws and had to adhere to a single system of tax collection. In other words GST also brought in a more centralized system of taxation with the Centre having an upper hand in terms of charging as well as collecting taxes. Consequently, a loss of revenue and loss of autonomy in revenue collection for the states. This was the cause of contention between the Centre and the states initially.
State Compensation
A consensus was reached between the Centre and States on the promise of 14% annual growth and a provision of compensation for any revenue loss incurred by them due to the implementation of GST. Thus, the GST compensation fund was set up and cess collected on ‘demerit goods’ would fund it. The loss was to be calculated with respect to the projected revenue growth for the state, per annum.
In the 41st meeting of the GST Council, the Revenue Secretary stated that the GST compensation fund was expected to face a shortfall of 2.35 lakh crore by the end of this financial year. Many of the goods in the ‘demerit goods’ category have been adversely affected due to the pandemic and ensuing lockdown. The automobile industry, one of the major contributors to the cess collections, had taken a massive hit. All this has resulted in reduced cess collections and thereby the shortfall. Allegations of diversion of surplus funds from the compensation fund to the consolidated fund have been levelled up against the Centre following a CAG report which observed the same. However, the Finance Minister has out rightly rejected any such mismanagement.
Two borrowing options were extended to the states to bridge this shortfall, both of which required them to borrow from the market. As disputes arose over the two borrowing options, Centre shifted its stance and agreed to borrow Rs.1.1 lakh crore on behalf of the states. The borrowing will happen through a special window that will be facilitated by the Ministry of Finance through the RBI, as per the 42nd GST Council. The move is a more responsible approach and was appreciated. However, states like Kerala and Chhattisgarh are pushing for the Centre to borrow the entire amount of the projected shortfall. It is important to note here that if the Centre refuses to relent, the onus falls on the states themselves to compensate for the remaining deficit.
In such a scenario, the states will have to search for other arrangements which will put an additional financial burden on them. This can result in reduced public spending on subsidies and other welfare schemes which in turn will have an adverse impact on the quality of the services provided by the states. Needless to say, the most vulnerable sections of the society, largely dependent on state support for their sustenance will bear the brunt. Regional imbalances will also come into play as some states are more self-reliant and arguably in a better position to raise revenues than the others. Maharashtra whose state tax revenues account for about 67% of their total revenues will have a comparative advantage when placed alongside the northeastern states whose state tax revenues are pitched below 10% of their respective total revenues; these states have largely been dependent on the funds devolved by the Centre. This will also further accentuate the fiscal imbalance between the Centre and the states. How the Centre manages to address these concerns is yet to be seen.
What are the options before the Centre?
The Centre have some options to choose from: They can extend the cess collection period beyond the stipulated time (which have been agreed upon in the 42nd GST council meeting) and bring more goods under the demerit goods category. There are also murmurs around raising the GST rate on these goods. However, that might not be a welcome move as it would mean a further increase in the cost of these goods and thereby reduced consumption and demand. This can also have an adverse impact on the economy considering that in the last few years Indian economy has been largely driven by consumption.
Another option before the Union is that they can source funds from the consolidated fund of India, like they did to meet the compensation fund shortfall for the last financial year. However, the union finance minister in her budget speech had said that the compensation to states will be limited to collections under the cess this year, relying on an opinion from the Attorney General stating lack of legal provision for such an act. Owing to the unprecedented environment, the Centre can reconsider its position. It can also be made in such a way that the amount borrowed from the consolidated fund can be reimbursed with the cess collections surplus, as and when they are available. Alternatively, the Centre can borrow the entire amount of the short fall, which is 2.35 lakh crore, instead of the partial sum it has agreed to. These can be lent out to the states as back-to-back loans as was initially agreed and thereby uphold the spirit of cooperative federalism. Furthermore, the Centre is obliged to uphold its legal and moral commitment to take a proactive step, failing of which will set a bad precedent, giving way to mistrust between the states and the Centre. Hence, it is imperative that the Centre revisits the ideals that laid the foundation of the GST regime- mutual trust and the spirit of cooperative federalism- and act accordingly. Besides, a strong national economy would be sustainable only with strong state and regional economies.