Despite its constitutional obligation, the centre has lagged behind in compensating states for their loss of revenue due to GST as it does not have enough money. The way out is to induce consumption

By Sumit Dutt Majumdar

The non-payment of a substantial amount of the promised compensation cess by the centre to the states has taken away the sheen from the much-acclaimed spirit of cooperative federalism in the context of the Goods and Services Tax (GST).

It was in 2006 that negotiations started between the centre and the states for finalising the form and structure of GST under the auspices of the Empowered Committee of State Finance Ministers. It was headed by Dr Asim Dasgupta, then West Bengal finance minister. From the beginning of the negotiations, a bone of contention was payment of compensation to the states by the centre on account of the apprehended loss of revenue due to GST.

During the UPA rule, when the negotiations started, the government was appreciative of the apprehensions of the states and was ready to compensate them through a suitable means to be determined later. But the states demanded that the promise of compensation be put in the Constitution. The UPA government refused and the negotiations suffered. In order to break the stalemate, a Constitution Amendment Bill for introduction of GST sans the clause for compensation was presented in Parliament in March 2011 by Pranab Mukherjee, then Union finance minister. However, it could not be passed due to strong opposition, led by the BJP.

After the NDA government led by the BJP came to power in 2014, it agreed to put the states’ demands for compensation in the Constitution.

Thus, Parliament passed the amendment Bill and it became the 101st Constitution Amendment Act, 2016. It dealt with the introduction of GST and clearly covered compensation by the centre to the states.

Section 18 of this Act that dealt with “Compensation to States for loss of revenue on account of introduction of goods and services tax” says: “Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the Goods and Services Tax for a period of five years.”

Subsequently, Parliament passed the GST (Compensation to States) Act, 2017. Its broad features are that the centre would compensate the states fully for the loss of revenue for five years a day after the GST was introduced.

In order to fund this, the centre would levy a cess on demerit goods and luxury goods that attract a GST rate of 28 percent, in addition to the revenue collected through the laid down GST rates. The entire cess amount was meant to be utilised by the centre to compensate the states.

This Act has 14 sections on subjects such as “Projected Growth Rate” of revenue, “Base Year” for calculation of the compensation amount, “Base Year Revenue”, “Projected Revenue for Any Year”, “Calculation and Release of Compensation”, “Levy and Collection of Cess”, “Returns, Payments and Refunds”, “Crediting Proceeds of Cess to Fund” and other issues related to cess. The Schedule attached to the Act specifies the list of items with their tariff headings and the maximum rates at which GST compensation cess may be collected. The Schedule includes items like pan masala, tobacco and cigarettes, coal, aerated water and motor cars.

Section 7 of the GST Compensation Act that deals with “Calculation and Release of Compensation” says: “The compensation payable to a state shall be provisionally calculated and released at the end of every two months period, and shall be finally calculated for every financial year after the receipt of final revenue figures, as audited by the Comptroller and Auditor-General of India”. Section 8 authorises the levy and collection of cess “for the purposes of providing compensation to the states for loss of revenue”. Section 10 provides for crediting the proceeds of compensation cess to the non-lapsable GST Compensation Fund which will be utilised for the purpose of payment of compensation to the states.

GST Compensation Cess Rules, 2017 have also been notified for adaptation of Central GST Rules, subject to certain modifications. Thus, a bridge was built between two sets of rules. It is, therefore, clear that it is the constitutional obligation of the centre to compensate the states every two months. But the problem is that the centre has not been able to collect adequate amount of compensation cess which was to be reimbursed to the states. In fact, the collection of GST itself has been significantly below the target. After the lowest dip of Rs 91,916 crore in September 2019, GST collections rose to Rs 1,03,492 crore, but that was mainly due to the festive demands of Diwali. It has to be seen whether this rise can be sustained.

Economic slowdown and tax evasion are the two main reasons for less collection of GST. The first one led to less consumption and hence, less supply and less collection of GST. Substantial evasion of GST, as recently revealed by the scale of detection of the evaded taxes, has also dented the GST kitty significantly. As compensation cess is also a levy on the “supply” of goods and services, its collection too has been hit.

The net result is that the centre does not have enough money to pay compensation to the states. Seven opposition-ruled states, including Punjab and Kerala, recently demanded immediate payment of pending cess of Rs 50,000 crore lying unutilised with the centre in the GST Compensation Fund. The states have said that in addition to the compensation for August-September, that of October-November is also due. This, they said, has impacted their public expenditure as well.

The centre reportedly told the states that while it will honour the commitment of GST compensation, there will be a delay due to inadequate collection of compensation cess.

This is bad news, not only for the states but also for the economy. There is no dispute that currently, it is public expenditure that is driving growth. Delay in payment or cutback of the compensation cess will lead to a cut in development expenditure by the states. In fact, states account for a greater share of total government expenditure.

So a cutback on the compensation amount will hit the development of states more and intensify the slowdown across the country.

The centre seems to be aware of this critical situation and hence is planning to discuss ways and means to revive the economy in the next GST Council meeting, tentatively slated for December, 18. There is talk of increasing the rate of compensation cess. There is even a possibility of rejigging the tax structure by increasing the GST rates of a few final products. This has been suggested in order to avoid the inverted duty rate structure where the finished product is exempted or it attracts a lower rate of GST as compared to the higher rates for the inputs. In such a situation, the unutilised input tax credit gets accumulated and becomes a “cost” to the supplier. This sounds good so long as the benefits of credit utilisation are truthfully passed on to the consumers and there is no price rise. Otherwise, it will cause more consumption worries.

The need of the hour is to facilitate revival of consumption. No step should be taken where it makes goods and services dearer, causing consumption worries which will, in turn, hit supply and result in less collection of GST as well as compensation cess. Keeping this in mind, any further increase in the rates of GST or compensation cess would have its own risks.

The solution will have to be found in reducing the income tax rate for the lower and middle income group in order to give a spurt to consumption. It is universally known that the moment extra money is available to both groups they spend it in purchasing goods and services. This is unlike those at the upper end who do not generally invest the extra money during bad times and prefer to save it for better times.

As for the demand for extending the compensation period beyond five years, i.e. 2022, it’s too early to take a view on this. This decision can wait till 2021.

—The writer is former Chairman, Central Board of Excise & Customs, and author of “GST–Explained for the Common Man”

Lead pic: Union Finance Minister Nirmala Sitharaman at the GST Council meeting in Goa