GST Compensation: The Trust Deficit Needs Fixing First
Prime Minister Modi needs to channel some Jaitley. He must bridge the GST trust deficit first, then worry about fiscal deficit.
One of the most important arguments in favour of implementing a goods and services tax across India was that it would eliminate the cascading effect of various indirect taxes. The GST Compensation Cess goes against that very principle. Not only does it burden a select set of goods with a very high tax rate, it is not eligible for input tax credit. And yet, this limited purpose levy, born with a defined five-year life span, is now set to overstay its welcome, further enfeebling the promise of a ‘Good and Simple Tax’.
The issue of GST compensation has been simmering for a year and culminated in a GST Council meeting that the Kerala Finance Minister Thomas Isaac described as a “a five hour ride”.
So far, the the union government’s two-option solution is somewhat confusing and mostly self-serving.
Constitution Over Law?
There’s a story Arun Jaitley told Parliament in 2016. About how the Indian Constitution, out of respect for Parliament, says “Parliament may...” when providing for legislation on an issue. But given the apprehension of states on the issue of compensation, the constitutional amendment to implement GST was worded “Parliament shall...”.
“This is going to be the only provision where Parliament is mandated rather than requested,” Jaitley said in acknowledgement of states’ fears.
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.The Constitution (One Hundred and First Amendment) Act, 2016
The states may have got what they wanted in words, but not in spirit.
Faced with a crippling revenue shortfall the centre has found a neat legal corner between the constitutional amendment and the 2017 compensation law to take cover under.
It agrees that it has a constitutional mandate to compensate states for a shortfall in GST revenue, and that, as per the compensation law, the shortfall is to be calculated against the promised 14% increase in revenue per year.
But it argues that
- According to the law, compensation can only be made via the GST Compensation Fund.
- If the fund has no money then no compensation can be paid.
- The Attorney General has advised an extension of the cess period to recoup funds.
One might argue, the same law also does not make any provision for late payment.
But let’s for a moment accept the centre’s convenient truth. What then explains this Rs 97,000 crore twist?
Rs 97,000-Crore Bogey
Why not just distribute what the compensation fund collects this year and let states find a solution to the fund shortfall? Extend the cess period to make good the compensation later.
Well, that’s exactly what the centre intends. Except, it had to dress it up to sell it.
That’s why it presented states “two options”. And came up with a Rs 97,000 crore computation.
The centre claims the total compensation payable to states in FY21 is Rs 3 lakh crore. It expects to collect Rs 65,000 crore via cess. The remaining Rs 2.35 lakh crore will fall short.
But, according to the Finance Ministry, much of that shortfall is on account of the pandemic. It thus arrived at Rs 97,000 crore as the amount it owes states on account of “…loss of revenue arising on account of implementation of the goods and services tax…”.
By the Finance Ministry’s own admission, neither the constitutional amendment nor the law allow any such break-up of the shortfall on account of an extraordinary event versus GST implementation.
Then why bring it up? Unless it’s to create an illusion of options.
Two Options = No Option
The word-parsing could have had some success if the centre had offered to pay states the Rs 97,000 crore this year. Many states might have settled for less with cash on the table.
But it hasn’t. Which exposes this entire option one/option two game for what it is.
In neither option is the centre offering states any money.
In both the states have to borrow. Either they borrow less (Rs 97,000 crore) with some incentives thrown in or they borrow more (Rs 2.35 lakh crore) but borrow they must to make up for the GST revenue shortfall.
All the centre has generously offered to do is facilitate the borrowing for states that agree to borrow less (option one).
Even that offer changes week to week.
No RBI Window
In the media conference following the last GST Council meet, Finance Ministry officials said option one involved state borrowing facilitated “through the Reserve Bank”, “a special window be provided in consultation with RBI”, “RBI or the lender” – all language that suggested some sort of borrowing via the central bank.
Whereas, under option two states would borrow from the market.
In a statement published two days later there was no mention of RBI. Only “special window coordinated by the Ministry of Finance“.
Last week, in an interview with BloombergQuint, Expenditure Secretary TV Somanathan clarified that even under option one, states would borrow as they ordinarily do, via the market, with some help from the centre to keep rates low and uniform. Maybe via by a letter of comfort.
“So, you could make a special issue of state bonds where we undertake and give a letter of comfort that the interest and principal will be serviced from the compensation cess account held by the Government of India,” Somanathan said.
It’s not clear why, if, by constitutional provision and law, compensation is due to states then they would need a letter of comfort from the centre to ‘securitise’ this revenue or borrow against it?
It’s also not clear what the implications of bestowing a superior claim on these special bonds versus ordinary state bonds would be on the state debt market.
Then there’s the other minor issue of a borrowing traffic jam.
Even if all states were to go for option one, and borrow Rs 97,000 crore, that’s approximately 20% of the net total borrowing via State Development Loans or Bonds last year.
That makes fund raising challenging in the second half even as the centre’s additional borrowing needs come into play.
Next Year, What?
Notwithstanding everything written so far states might, in sheer desperation for cash, agree to borrow and expect to compensated by an extension of the cess levy beyond 2022 when the five-year period runs out.
Problem solved.
Till next year.
If, in a pre-Covid year (FY20) the compensation cess collections fell short, then what are the chances that in a Covid-continuing year (FY22) they won’t?
Will states have to borrow next year as well to meet the shortfall? Will the centre yet again put forth a two-option, no option proposal with an imaginary window?
And for how many years will the cess have to be extended to recoup this year’s and next year’s shortfall?
Can Modi Do A Jaitley?
No doubt this is an extraordinary situation and the union government is in a genuine spot on account of the steep pandemic-led fall in revenue.
Some, like economist and former finance secretary Vijay Kelkar, might say, assured compensation at 14% CAGR was too aggressive to begin with. It discouraged states from seeking an efficient GST.
Once such a generous guarantee package was announced, incentives for state governments to press for an efficient and effective GST structure, weakened. The Centre’s incentive was to carry all the states along in the Council, even if, during this process, the GST was enfeebled.Paper by V Bhaskar and Vijay Kelkar - Pune International Centre
Others may argue that a VAT-like tapering compensation rate would have been better. Though states rejected that in 2016.
Or, if the centre must reform (cut wasteful expenditure, disinvest etc…) then why shouldn’t the states.
All fair points.
The centre may be right in seeking the states share some of the burden.
But to get some you must be willing to give some, as Jaitley demonstrated when acquiescing to state demands to usher this tax in.
This current negotiating stance of the central government gives states nothing. Instead it worsens the uncertainty around a tax that has failed to deliver the anticipated GDP boost and remains riddled with design and implementation flaws.
Four years ago, Jaitley described the GST as “a new idea where a pooled sovereignty will come in”.
If that idea and this tax has to survive then Prime Minister Modi needs to channel some Jaitley. He must bridge the trust deficit first and then worry about the fiscal deficit.
As economist Ajit Ranade points out, he could agree to borrow and compensate states this year in exchange for a slash in the 14% guarantee next year.
Menaka Doshi is Managing Editor at BloombergQuint.