Less than three months from now June 30, 2022 will be an important milestone under the national Goods and Services Tax (GST) regime that was launched on July 1, 2017.
In the follow-up to The Constitution (One Hundred and First Amendment) Act, 2016, that introduced the GST, the Union government had also introduced The GST Compensation Act, 2017. It provides 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 percent 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 percent – other slabs being five percent, 12 percent and 18 percent 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 a period of 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.
Even as this deadline is few months away, States have been pestering the Central government to continue the compensation for 5 years (earlier they had made a similar request to the 15th Finance Commission). The grounds on which their demand is based are: (i) they continue to face shortfall in tax revenue and (ii) Covid – pandemic has severely impacted their revenue – both their own tax collection as well as transfer from the Centre – pushing them behind the curve.
At the outset, let us get a sense of the quantum of shortfall in tax revenue experienced by the States during these 5 years and the extent to which collections in the cess plugged it. During July 2017-March 2018, the shortfall was Rs 41,150 crore. Against this, the cess collection was Rs 62,600 crore leaving a surplus of Rs 21,450 crore in the pool. During FY 2018-19, the shortfall was Rs 69,000 crore but the cess collection was higher at Rs 95,000 crore leaving a surplus of Rs 26,000 crore.
At the beginning of FY 2019-20 thus, there was a surplus of about Rs 47,500 crore (21,450+26,000) in the cess pool. During 2019-20, the shortfall was Rs 165,000 crore against which the cess proceeds were Rs 95,000 crore. This resulted in a deficit of Rs 70,000 crore. Even after using 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 Rs 300,000 crore; courtesy, the devastating effect of Covid pandemic on economic activity and resultant dip in tax collection of both the States and the centre. Against this, cess proceeds were only Rs 65,000 crore (a plunge of almost 40 percent over the previous year), leading to an unmet deficit of Rs 235,000 crore. To make up for this gap as also the unmet deficit of 2019-20, the Centre, in consultation with Reserve Bank of India (RBI) set up a special window for borrowings at “low” rate of interest and transfer the funds to states as back-to-back loans. Under this window, Rs 270,000 crore was borrowed, Rs 110,000 crore during 2020-21 and Rs 160,000 crore during 2021-22.
Meanwhile, during FY 2021-22, the States’ shortfall in tax revenue is estimated to be about Rs 150,000 crore. Against this, the cess collection till February, 2022 was Rs 90,000 crore; for the whole year, it won’t exceed Rs 100,000 crore. The resultant unmet deficit of Rs 50,000 crore will also have to be plugged by borrowings under the ‘special window’ for transfer to the States. This takes the total borrowings to Rs 320,000 crore which could increase further to accommodate any mismatch during April – June, 2022.
In view of above, even though as per the extant law, the compensation arrangement has to end on June 30, 2022, it will have to continue if only to service this loan. In turn, this requires that the cess on demerit products will have to continue till such time all loan-related liabilities are fully extinguished. This will require further amendment to the GST Compensation Act (2018) to provide for levy of the cess for the extended period.
While, this part has been agreed upon (in fact, this is ‘built-into’ the arrangement for borrowings under the ‘special window’), the States want that compensation should continue for another five years to ‘make up for the shortfall in tax revenue that they would face during this period i.e. up to June 30, 2027’. This is an abhorrent proposition.
The raison d’etre behind giving the States a buffer (read: compensation) over a fairly long period of 5 years 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. If, even at the end of this transition, they need crutches and that too for another five years, it points towards something fundamentally wrong with the way they have worked through.
The pandemic argument does not cut ice as 2021-22 being almost free from the Covid (thanks to a mammoth vaccination covering almost all age-groups) has been exceptionally well in terms of GST collections which are expected to touch a record Rs 1500,000 crore. From hereon, both the Centre and the States should look forward to better the performance; hence no need for support.
But, even during 2021-22 , the States faced shortfall of Rs 150,000 crore which the Centre is compensating. This is baffling. It may have to do with the formula for determining the shortfall. Under it, the target revenue (TR) is arrived at by applying annual growth at 14 percent over the 2015-16 level of tax revenue under the erstwhile dispensation. TR gets unduly inflated due to (i) the base itself being high (that regime was characterized by high tax rate); (ii) compounding effect of the percentage growth which is maximum in the 5th year (for instance, @14 percent, Rs 100/- will become Rs 193/-).
The aberration of 2021-22 should not be allowed to obliterate the view of the Union government/GST Council in regard to the future. Put simply, having already been under the new regime for five years (albeit with support) and tax collections under GST – both by the Centre and States – improving and the economy expected to gain momentum in the coming years, there is no justification to continue with the compensation.
Instead, the GST Council should now focus on measures to make tax collection more ‘robust’ and ‘buoyant’.