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There are no bad guys in India’s muddle over GST compensation

The GST shortfall of states can’t be blamed on the Centre, whose offer of credit was made in good faith

The issue of compensation to be paid to states for shortfalls in the collection of Goods and Services Tax (GST) is great material for discussion in classrooms. One can debate it until the cows come home without reaching any conclusion. Point-scoring is not problem-solving.

The two options presented by the Union government to the states are now in the public domain, and I do not have to restate them. Readers are better off consulting the official version. At the heart of the dispute between some states and the Union government is the extent of the shortfall arising out of GST implementation. The Union government estimates that figure at 97,000 crore. States contend that the shortfall is due not just to GST implementation, nor mainly to the pandemic, but due to an economic slowdown for which they hold the Centre responsible. Without such a growth slowdown, there may not have been a shortfall in the GST collections of states—to be met with cess revenues. Economic growth slowed sharply in 2019-20. Nominal gross domestic product (GDP) growth dropped to 7.2% in the year ending 31 March 2020, and real GDP to 4.2%, from 11.0% and 6.1% respectively in 2018-19. The problem is one of assigning responsibility for it.

Monetary policy played a role. It is both possible and reasonable to take the view that it was too tight in 2017 and 2018. Indian statistical agencies had a role. The GDP estimation methodology showed higher growth than what actually obtained in 2016-17 and 2017-18. This played a role in dulling responses both from the Centre, in terms of structural reforms, and from the central bank by way of monetary policy.

Global growth also fell, and so did India’s export growth. The slowdown was not unique to India. Brazil and Indonesia have suffered far worse export slowdowns than India has in the last few years. Both are large emerging economies. Further, if one went back and looked at growth across nine key emerging economies since the turn of the decade, real GDP growth has slowed sharply in all of them. So, pinning the blame on the Union government for the economic growth slowdown and hence the decline in GST collections is quite a stretch.

The second question is whether the Centre had a moral obligation to compensate states from the Consolidated Fund of India. GST adoption has been a national effort for at least 15 years before it became a reality. India’s two major political formations, along with their coalition partners, had tried to advance the cause of GST when they were in office. All states eventually signed on because they believed that higher GST revenues would compensate for loss of revenue autonomy. It did work for several states, including for Tamil Nadu, which had opposed the idea; its GST collections rose faster than its pre-GST sales tax revenues did. Therefore, it is not correct that states acquiesced in the introduction of GST as an act of benevolence towards the Union government. A few facts would help take the partisan edge off the debate.

The total shortfall in GST due to states (protected revenue at 14% compounded annual growth minus estimated actual revenue) is 3 trillion. Net of compensation through cess, the amount drops to 2.35 trillion. If states opted for the first option given by the Centre, they would get 2.62 trillion, including the compensation cess. That is 87% of the shortfall. This option will enable borrowing of approximately 1 trillion. That is because states will be able to borrow the final instalment of 0.5% (originally intended as a bonus for completing at least three of the four specified reforms set out in May) even without meeting the pre-conditions. Through option 2, they can cover the entire shortfall, but the terms are not great. Importantly, under both the options, whatever is not borrowed by states will still be paid to them even after 2022, through an extension of the cess. The delayed payment may be a blessing in disguise for states to manage the transition to a post-compensation GST era. Finally, GST has actually delivered 14% revenue growth to all states for the period till the end of last financial year. So all dues have been settled for a total of 2 years and 9 months out of 5 years.

The growth malaise is global and the pandemic has been an unfortunate and involuntary import. Facilitating borrowing by the states without affecting their debt ratios and arranging to clear any arrear of compensation through future compensation cess collections are “good faith" efforts on the Union government’s part. The reliance on future compensation means that taxpayers will have to bear the cost. This is inevitable and is happening in other countries too. Singapore, for example, is contemplating revenue measures to rebuild its depleted fiscal reserves.

One point that the GST Council should discuss but hasn’t, is this: both the Union government and States sacrifice fiscal revenues and incur expenditure for many considerations other than national interest alone. The GST compensation crisis is an opportunity to rescue the country’s long-term fiscal health from political arbitrage.

Incidentally whether the pandemic is an act of God or a laboratory is yet to be established. These are the author’s personal views.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister.

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