Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions?

Answer

Approach:IntroductionGive a brief description of GST and the compensation clause.BodyEnlist the rationale behind GST Compensation.Discuss the impact of the pandemic on this provision along with the federal tensions created by it.ConclusionConclude stating that there have been issues in GST compensation due to structural issues as well as the pandemic, but it has been resolved now as the provision hasn’t been extended.

Introduction

The Goods and Services Tax (compensation to states) Act of 2017 isa legal assurance given by the Union government to compensate states for loss of revenue for a period of five yearsas per section 18 of the Constitution (101st Amendment) Act, 2016. It calls for a compensation by the centre to the states upon a shortfall of revenue of 14% or more under GST till June 2022.

Body

Rationale behind GST Compensation Act:

• Fixed revenue growth:The centre assured a 14% year to year growth on GST revenues for a period of five years. The centre assured states to compensate states for any loss on tax revenue due to GST. If such assurance was not available, the states would have been hesitant to come along in implementing GST.


• Compensation for manufacturing states:The states like Maharashtra, Gujarat, and Tamil Nadu lost a portion of their revenue as GST is a consumption tax, and thus the tax amount goes to the state of consumption rather than manufacturing state as earlier.


• Alternative revenue source:State governments lost their power to raise revenue from alternative indirect sources after GST. Under the GST regime, states are required to subsume several indirect taxes into a single tax, which could potentially result in a reduction in the revenue of states. This deficiency was fulfilled by the union government by compensating them with a fixed amount regardless of the situation.


• Create constitutional liability:The Act created a constitutionally binding agreement between centre and state regarding GST compensation. This gives States an assurance as well as a mechanism to enforce their claim as a right.

COVID-19’s impact on GST compensation fund and federal tensions:

• Lower tax collection for states:The slide in economic activities due to the imposition of localised lockdowns to deal with Covid-19 strained the fiscal position of state governments. The States were looking towards the Centre to fill this fall in revenue.


• Non-Uniform Impact:Considering that the virus spread and lockdown restrictions have varied across states, the loss across states was not uniform. So, states are competing to gather as much as they can from the Centre.


• Uncertainty about future:Uncertainty over the states’ revenue stream, especially when they have to ramp up spending for fighting the pandemic, complicates the task of fiscal management.


• Backlog:The Centre has been postponing payment of GST compensation due to reduction in revenues. This has led to piling up of the compensation to be paid and furthering tensions between the centre and the states.


• Some states are demanding compensation on all of the tax revenue lostdue to the pandemic but the GST compensation is meant to be only for loss due to implementation of GST.


• Issue of borrowing:The Centre was asked to borrow funds to meet the shortfall in the compensation fund.

Conclusion

The 15th FC report had projected that the gap between GST cess collections and the revenue shortfall faced by the States for implementing the GST could snowball into a much larger amount. Larger GST collections for the past one year have assuaged these tensions to some extent as the compensations have been largely paid off. In future, the revenue base for the purpose of the calculation, the time horizon for the levy, should be amicably discussed.