With loans likely to be repaid by January 2026, the question arises—can the continued levy of the cess be logically justified in light of buoyant tax collections
In its meeting held early this month, the GST Council had decided to set up a Group of Ministers (GoM) to suggest ‘how to go about the GST compensation cess, which is levied on luxury, sin and demerit goods such as automobiles, aerated drinks and tobacco, after the loans taken to meet the shortfall in revenue of states during Covid-affected years are repaid. The GoM will be headed by Union Minister of State for Finance Pankaj Chaudhary and include members from states. The statement ‘how to go ……’ together with reports suggesting that the GoM will be reworking the nomenclature for GST compensation cess points towards the intent of the GST Council to continue its levy even after the deadline of March 2026 when it is to be withdrawn as per the subsisting arrangement. The matter requires deeper examination. The key question is: Why should GST Cess be continued? In the follow-up to The Constitution (One Hundred and First Amendment) Act, 2016, which introduced the GST, the Union Government also introduced The GST Compensation Act, 2017. It provided for compensation to the States for five years (2017-18 to 2021-22) for the loss of revenue to be calculated as the difference between their actual collection (including transfer of their share in indirect tax collected by the Centre) and the amount they would have got with annual growth at 14 per cent over the 2015-16 level under the erstwhile dispensation (Central Excise Duty (CED)/service tax/sales tax/Value Added Tax (VAT) plus other local taxes).
To discharge this obligation, the Centre also passed an amendment to the GST Compensation Act (2018) to levy a cess on the so-called demerit goods (those which fall in the highest tax slab of 28 per cent – other slabs being five per cent, 12 per cent and 18 per cent besides the exempt category) such as automobiles, tobacco, drinks and so on with a proviso to use the proceeds for compensating States. The cess was to remain in force for five years in sync with the commitment to compensate States for that period.
The rationale behind keeping these arrangements in place for five years was that at the end of this transition, i.e., June 30, 2022, the GST dispensation would have acquired the much-needed “vitality” and “resilience” to yield sufficient resources for the States to meet their budgetary requirements within a prudential limit set under the Fiscal Responsibility and Budget Management Act (FRBM) thereby obviating the need for any extra support beyond this deadline. However, even before the June 30, 2022 deadline arrived, the States had been clamouring for continuing the compensation beyond it. So, first, they requested the 15th Finance Commission to extend it for five years not realizing that the mandate for this is with the GST Council. Thereafter, they started pestering the Central Government.
The States gave two reasons for their demand (i) they continued to face a shortfall in tax revenue and (ii) The – pandemic had severely impacted their revenue – both their tax collection as well as transfer from the Centre – pushing them behind the curve. We need to look at the factual position on the quantum of shortfall in tax revenue experienced by the States during those five years and the extent to which collections from the cess plugged it. From the time GST was introduced on July 1, 2017, till March 31, 2019, collections from the Cess exceeded the shortfall resulting in a surplus of about Rs 47,500 crore in the pool. However, the equation changed in the subsequent years. During 2019-20, the cess proceeds were Rs 95,000 crore against a shortfall in tax collection of Rs 165,000 crore resulting in a deficit of Rs 70,000 crore.
Even after using the surplus from the previous two years, the unmet deficit carried forward to the next year was Rs 22,500 crore. During FY 2020-21, the shortfall in tax revenue zoomed to over Rs 300,000 crore; courtesy, of the devastating effect of Covid pandemic.
Against this, cess proceeds were only Rs 65,000 crore, leading to an unmet deficit of Rs 235,000 crore. During FY 2021-22 also, the collections in the Cesspool couldn’t fully meet the shortfall in tax collection though the deficit was much less. To make up for the deficit, the Centre, in consultation with the Reserve Bank of India (RBI) set up a special window for borrowings at a “low” rate of interest and transferred the funds to states as back-to-back loans. Under this window, it borrowed a total of Rs 270,000 crore including Rs 110,000 crore during 2020-21 and Rs 160,000 crore during 2021-22. To generate the required money to repay the loan and interest, the GST Council decided to extend the cess till March 2026.
The necessary amendment was made to the GST Compensation Act (2018) to give effect to this decision. According to the Union Finance Minister Nirmala Sitharaman, the entire loan of Rs 270,000 crore would be fully serviced by January 2026, two months ahead of the March 31, 2026 deadline.
As per estimates, the collections from GST compensation cess in February and March 2026 are expected to be about Rs 40,000 crore. How this surplus money would be apportioned between the Centre and States is a task the GoM will have to carry out. The States want the GST compensation cess to continue even beyond March 31, 2026.
Naturally, its continuation can’t be justified in terms of the need to service loan liabilities from the past; those would have already been extinguished before that. Do they have any logical argument? To say that they require more revenue to meet the development needs, as reported, is plain rhetoric. Tax collection is far from being a constraint. Only a couple of years ago, top officials in the Department of Revenue used to gloat over a collection of GST Rs 150,000 crore if achieved in any given month. Since, the beginning of FY 2022-23, monthly GST collections have been more than Rs 150,000 crore.
In fact, during FY 2023-24, the average monthly GST collection was even higher at Rs 168,000 crore. Therefore, Cess’s continuation on the basis that there could be a shortfall in tax collection is untenable. The raison d’etre behind giving the States a buffer (read: compensation) over a fairly long period of 5 years (2017 – 2022) was to ensure that they get adjusted to the new dispensation and are in a position to garner enough revenue thereby obviating the need for any further support. At the end of this transition, it is only apt that the buffer should go.
The buoyancy in GST collection since 2022-23 reinforces the case for withdrawal of compensation cess. Meanwhile, taxing petroleum products under GST has been pending for long. Currently, these are taxed under the pre-GST regime entailing a much higher level of levy. For instance, in Delhi, the taxes (central excise duty or CED plus VAT) account for about 80 per cent of the ex-refinery price of petrol.
Taxing it under GST will result in lowering this to 28 per cent (even if it is put in the highest slab). This will end up reducing tax collection in the States by over one-third. To help them make up for this loss, the GST Council may consider extending the Compensation Cess with a sun-set rider of say five years.
(The writer is a policy analyst; views are personal)
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