Six years of GST: Compensation cess still needs to be sorted out

On 1 July 2023, India’s goods and services tax (GST) marked its sixth anniversary. I wrote a five-year review last year (Mint, 1 July 2022), commending its compliance simplification after a bad start. I also strongly proposed universal access to the Reverse Charge Mechanism (RCM) to help resurrect informal manufacturing and services. An explicitly permissible feature in the Central GST Act, a universal RCM was ruled out by notification soon thereafter, essentially destroying unregistered small-scale activity. My call has sadly gone unheeded.

The fifth anniversary last year also marked the end of the five years over which, under the GST Compensation Act of 2017, the Central government underwrote a 14% yearly increase in GST revenue for every state, starting from the yield in 2015-16 of state taxes replaced by the GST. I have written elsewhere on why guaranteeing a uniform 14% annual increase was not equitable across states, and will not deal with that issue here. There has been greater revenue vigilance by states post-compensation. Service providers with a presence in multiple states should have seen this coming, but apparently did not.

GST compensation was funded by a cess leviable on specified goods listed in a schedule to the 2017 Act—principally tobacco, coal-based solid fuels and fossil-fuelled motor vehicles (but open-ended to include “any other supplies”). It was quite an extraordinary statutory commitment to a revenue top-up that could not be projected with any accuracy. Then there was the pandemic, when the compensation required soared even as cess collections dived. That mismatch was resolved by the Centre undertaking special borrowing to cover the deficit.

My objective here is simply to take stock of the overall compensation payout over the statutory five years, as officially reported, and the overall cess collected.

Arriving at the flow of compensation paid was not easy. I pieced together responses to two Parliamentary questions dated 21 March 2022 (Lok Sabha) and 19 July 2022 (Rajya Sabha), and a finance ministry press release dated 31 May 2022 which listed arrears paid during the months of April and May 2022. The dues for the last month of the statutory period, June 2022, along with some further arrears of ₹0.16 trillion payable, were announced as recently as the 49th meeting of the GST Council on 18 February 2023.

Adding on all arrears including the most recent, states received ₹5.89 trillion in GST compensation for the five-year statutory period (average of ₹1.18 trillion per year). The average annual revenue from the cess over the same period (including April to June 2022) was ₹0.96 trillion, below the average annual compensation required. Even when cess collection over the full financial year 2022-23 is included, total cess revenue at ₹5.76 trillion (including imputed values for two covid months) is below the ₹5.89 trillion payout.

So it should not be surprising that arrears of ₹1.06 trillion got backloaded onto the end of the statutory period and beyond. But the cess deficiency was not uniform across all years. There was a cess surplus in the pre-pandemic year 2018-19, for example, despite which arrears of ₹0.15 trillion were not paid until the start of 2022-23. The most likely reason is delay in supply of audited figures of state revenues, possibly exacerbated by late cognisance at the Centre of (delayed) information supplied. The lack of timely auditing of the finances of (some if not all) state governments is among the serious structural defects in the Indian fiscal system.

So where does the cess go from here? In September 2021, at the 45th meeting of the GST Council, it was proposed that the cess be extended to March 2026 to cover repayment of the Centre’s special borrowing to cover compensation over the pandemic years. At its most recent meeting (50th) on 11 July 2023, the GST Council has recommended amending the Compensation Act rules to expand the definition of vehicles taxable under the cess. Is the cess being visualized as a permanent supplement to the GST?

The GST Compensation Act does permit a surplus in the compensation fund to be split in a specified way between the Centre and states. But when its statutory function including repayment of debt is over, it needs to come under a separate rubric from the Compensation Act. The need of the hour is to think ahead on how to repurpose and rename the compensation cess on tobacco, coal and fossil-fuelled transportation, as a Pigouvian levy on goods which generate negative health or climate externalities. But the proceeds of such a (climate?) cess have to be put to the best uses as judged by the excellent scholars working in India on climate action. Also to be thought through now is the process by which the effectiveness of those critically needed expenditures can be tracked.

Total GST revenue as reported every month by the government includes revenue from the compensation cess, which has been remarkably stable at 7-8 % of the total. When the cess is removed and placed under another head, the GST revenue series will have to be re-generated with cess revenue excluded. In July 2023, total GST revenue was reported as ₹1.651 trillion. With the cess excluded, it stood at ₹1.533 trillion.

Indira Rajaraman is an economist.