The issue of compensating the states for ‘loss’ of revenue due to migration to the Goods & Services Tax (GST) regime has hit the headlines yet again—this time the trigger being the reported statement of the Finance Secretary to the Parliamentary standing committee on finance that the Centre is not in a financial position to compensate.

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Compensation to the states for loss of revenue, arising on account of implementation of the GST, for a period of five years was a commitment brought about by the Constitution (one hundred and first amendment) Act 2016. The methodology of calculation was a result of animated discussions spread over the first few meetings of the GST council where proposals ranging from considering an average revenue of 3 years to 10 years were discussed before a consensus was finally arrived at. It was agreed that a projected 14 percent growth rate during the transition period with the base year being the financial year ending March 31, 2016, would be the basis for calculating the ‘loss’. This got translated into the GST (Compensation to States) Act 2017.

What this commitment meant was that compensation would be calculated assuming growth of 14 percent on the base year of 2015-16, and the difference between this figure and the actual revenue of a particular year would be compensated—the point being that the ‘loss ‘is not actual but as a result of the mathematical gymnastics showing 14 percent growth (which incidentally was not achieved by any state) whereby the Centre was giving the task of compensating’ something which was never in the first place lost.

The 27th July Press Information Bureau (PIB) report on the quantum of compensation released in 2019-20 makes very interesting reading—compensation has been given to states likes Tripura (Rs 293 crore), Meghalaya ( 157 crore), Bihar ( 5,464 crore), Assam (1,284 crore)—states which were expected to be the beneficiaries of a destination-based tax regime and were never in the reckoning when compensation was being thought off. It was expected that such a mechanism was required for the manufacturing States only—Karnataka, Gujarat, Maharashtra, Tamil Nadu and the like. However, out of the 31 states and Union Territories, all but 5 have been compensated thanks to the very generous mechanism of calculating ‘loss'.

Again, the PIB release reveals that as against an amount of Rs 1.65 lakh crore given as compensation, the compensation cess collected is only Rs. 95,444, leaving a balance of nearly Rs. 70,000 crore which has been met from the balance cess collected in the earlier years, and worse by dipping into the Consolidated Fund of India. Incidentally, the GST (Compensation to States) Act categorically states that all amounts payable to the states shall be paid out of the compensation fund. Given the sharp drop in economic activity, the compensation amount is only going to increase dramatically.

What then are the solutions? Increasing the number of goods on which compensation cess can be imposed, so that there is money available to compensate or increasing GST rates so that the amount to be compensated reduces, are difficult political calls. Another suggestion has been made that the government should borrow to compensate the states. The 8th GST council meeting had in passing discussed this as a possible solution in the event of a shortfall—this will need to be examined in depth; who will borrow, how will you repay, does it mean extending the cess collection beyond 5 years to repay the borrowing?

The Centre should also explore the possibility of reworking the compensation formula for the years 2020-21 and 2021-22 in close consultation with the GST council. Every force majeure situation permits a renegotiation. The fiscal crises are not just the problem of the Centre—the states do need to chip in. The assumed 14 percent growth rate needs to be reworked to a more realistic rate. This is obviously going to be challenging—the Centre will be seen as reneging on its promise but then again, what are the options available?

The states which have, on the promise of compensation been lulled into revenue complacency, need to be urged to mobilise revenue. We need to plug evasion—more than 3 years after the launch of GST we cannot afford to keep having leakages. The long-awaited simplified return and matching of invoices should be implemented. The audit which in the absence of regular filing of returns has yet to commence should be started without any further delay. This is yet another opportune moment to look closely at expanding the GST coverage—petroleum products, real estate, electricity should be brought within the GST ambit, exemptions should be reduced.

There are no easy answers—the Centre has its task cut out.

—Najib Shah is the former chairman of the Central Board of Indirect Taxes & Customs. The views expressed are personal

Read his other columns here

First Published:Aug 7, 2020 5:07 PM IST