THE refusal by the central government to pay the Goods and Services Tax (GST) compensation due to the states is patently illegal and violative of the constitutional scheme regarding relations between the centre and the states. The finance minister, Nirmala Sitharaman, announced in the GST council meeting held on August 27 that the central government was unable to pay the compensation amount to the states in 2020-21 as there was a big shortfall in the compensation cess collected and the revenue accruing to the government.

According to the finance minister, the cess collection this year is projected to reach only Rs 65,000 crore while Rs 3 lakh crore compensation is due to the states.  Hence, there will be a shortfall of Rs 2.35 lakh crore.  The finance minister termed this crisis in tax revenue as an “Act of God” and washed off all responsibility on the part of the centre to fulfill its commitment. 

When the GST plan was being put in place, the centre had promised the states that any shortfall in the projected 14 per cent growth in revenue annually of the states would be compensated in full for five years beginning from the financial year 2017. This commitment was reflected in the GST (Compensation to States) Act of 2017 which incorporated this provision. This was done to persuade reluctant states to give up their constitutional right to levy taxes.  

The invocation of an “Act of God” or force majeure is irrelevant and does not apply in this matter as it was part of a constitutional arrangement between the centre and states with regard to sharing of tax revenues. Moreover, the finance minister herself has stated that a shortfall occurred in collections from the cess in the previous year too, in 2019-20. According to the finance ministry, compensation to states worked out to Rs 1.65 lakh crore while collections from the cess stood at Rs 95,500 crore. The fact is that GST revenues and compensation cess have been stagnant or declining as the economic slowdown had already occurred much before the pandemic struck the country. 

After reneging on its commitment, the centre proposed two options for the states to borrow funds to meet the shortfall in the compensation due to them.  Both these proposals are iniquitous and boil down to the states incurring debt and being burdened with interest payments. 

Instead of getting what is due to them statutorily, the states would get into a debt trap and would be burdened with the cost of servicing the debt in future when there will be no compensation fund available to cover revenue shortfalls.

The centre’s stance of not paying what is due to the states is all the more shocking at a time when the states are on the frontline dealing with the pandemic with all the enhanced expenditure involved in health and welfare measures. The financial crisis imposed on the states can be illustrated with the case of Kerala. For four months of this financial year – from April 1 to July 31 – the compensation due to Kerala amounts to Rs 7,100 crore. If the centre does not pay for the rest of the year, then the state will be deprived of Rs 16,000 crore. This will seriously affect the ongoing efforts to tackle the pandemic and the relief and welfare measures that have to be extended to people in these times of economic crisis. 

The only way out is for the central government to borrow and fund the compensation to be paid to the states. The centre borrow from the Reserve Bank of India at a low rate of interest – such as the repo rate that the RBI extends while lending to banks, as suggested in the Economic Notes column in this issue. 

Most of the state governments are for the centre borrowing to pay the compensation dues. Already six state governments have written to the prime minister rejecting the proposal for states to borrow and asking the centre to do so. More are to follow.

It is also time to take a second look at the GST system.  In the three year period since it began, GST has not been able to generate the expected revenue increases. Apart from the Covid period, the tardy growth of the economy will mean stagnation and shortfalls in revenue generated by GST. This will not only affect the states but the centre too.

The Covid pandemic and the severe economic contraction have brought out in stark terms the helplessness of the states after surrendering their right to levy taxes.  The attitude of the centre and Narendra Modi’s favourite slogan, `One Nation, One Tax’ is inherently anti-federal.  This is in line with the centralising drive of the Modi government which has eroded states’ rights in various spheres.

The GST has only reinforced the fiscal authoritarianism of the centre and reduced the states to the status of mendicants.  All these underline the need to overhaul the GST system, or, better replace it altogether. 

(September 2, 2020)