Making States Borrow Is Against Spirit Of GST Pact: Ex-Finance Secretary Subhash Chandra Garg
The chief ministers of Uttar Pradesh, Uttarakhand, and West Bengal at a NITI Aayog Governing Council meeting, in New Delhi, on June 17, 2018. (Photograph: PIB)

Making States Borrow Is Against Spirit Of GST Pact: Ex-Finance Secretary Subhash Chandra Garg

BloombergQuintOpinion

The central government should borrow and compensate states for the GST revenue shortfall, says former Union Finance Secretary Subhash Chandra Garg. “That would be in line with the commitment which was made in 2016-17.”

The 41st meeting of the Goods and Services Tax Council concluded on Thursday with the union government proposing that states undertake additional borrowing to bridge the compensation cess shortfall for the 2020-21 financial year. A shortfall that the centre is constitutionally bound to compensate. In the first of two borrowing proposals—states have been given the option to raise Rs 97,000 crore from the Reserve Bank of India via a special window. According to the centre, that is the amount of the shortfall due to GST implementation, the rest of which is due to the Covid-19 pandemic. In the second option, states would be asked to borrow the full revenue shortfall of Rs 2.35 lakh crore.

Such an arrangement is not in conformity with the spirit of the pact that was reached between the central government and states in 2016-17, says Garg, a veteran of past GST Council meetings. Adding that a shortfall in GST payout to states is unlikely to go away even in 2022, Garg called for the centre to borrow the required funds, make the transfer to states as compensation, extend the cess past 2022 until that sum is recovered. If states are asked to borrow, they might demand another five-year cess, he cautioned in an interview to BloombergQuint.

States that are getting disillusioned need to be kept on the GST bandwagon by a 2016-like commitment from the central government, Garg said.

You have participated in the GST administration process from the very first week that it came into force in July 2017. Do the options that were considered by the GST Council in addressing the shortfall on compensation to states, and the two proposals made by the centre to states, stand true to the legislative framework as was put in place three-four years ago?

The legislative framework gives the mechanics of how to raise the necessary compensation cess amount to pay to the states. At the time when GST was being brought in, the central government that brokered the deal with states made a very solemn commitment that the states would be compensated if there is a shortfall, and revenue growth is not 14% compounded. That compensation is to be in the form of tax revenue. So the central commitment at that time was to compensate for the shortfall in the form of revenue. That was solemnised in the Constitution and the GST (Compensation to States) Act was enacted. That provides the mechanics to have the Compensation Cess on certain kind of commodities. If there is a shortfall, you can put the cess on other commodities, but that would be provided. At the time, this was the way envisaged for the compensation to be provided.

Now, as it happened that because of the decision taken on the lockdown and putting the economy under a certain kind of closure, GST revenues suffered. They were suffering even otherwise because of the lack of growth in the economy. As you saw, last year (FY20), there was a massive shortfall.

The shortfall in GST is going to be a long-standing feature until 2022, till which point there is a commitment.

2019-20 you had a massive shortfall, 2020-21 you would have a massive shortfall, and 2021-22 also you will have a massive shortfall. So let’s be prepared for that.

My assessment is that the way that should be devised is how do states get compensated in revenue during this period of two years – FY21 and FY22. That is the first thing. We should not hide behind the legality by saying that the cess has to be the means to provide the compensation. While that is correct because that’s the mechanics, it was thought this was the way the necessary amount would be raised.

What I gather from Thursday’s meeting is that the [central] government accepts that the states have to be compensated for the loss. They are not denying that commitment. They also say that ‘the means available to us (centre) is the GST Compensation Act’. That is correct, in that it is the primary means to do so. In the normal course, additional cess should have been levied on more commodities and then compensate. If you are not willing to do that and states may agree as well that the circumstances are not [conducive] at the moment for raising taxes on the commodities, then you have to go for extraordinary measures.

The extraordinary measures can be of three kinds:

  1. The central government borrows and provides the compensation in the form of revenue transfer to states.
  2. The GST Council borrows and provides to the states in the form of either debt or revenue.
  3. States raise debt for the shortfall, hoping… and all in these three means… that this has to be recovered later, after 2022. There is no chance that before 2022 you can recover it. So that temporary borrowing has to be paid back by extending [the cess] beyond 2022.

Of the three courses available, in my judgment, the best is that the central government borrows and provides to the states in the form of revenue. That would be in line with the commitment which was made in 2016-17. That would prevent states from borrowing excessively. They are, in any case, borrowing at an extraordinarily high level because of the other shortfall in their revenue. Why burden them with additional things? The central government, in any case, has the authority, power, precedence of borrowing in times of crisis. So let the centre borrow, provide it to states in the form of compensation and recover it after 2022 from the cess which is extended for the number of years it needs to be done.

The two proposals put forth on Thursday involve different amounts but both put the onus and action of borrowing on the states and not a revenue transfer following borrowing by the centre. You spoke of the legislative framework – do these proposed models meet the promise of the concept and spirit of burden sharing that was set out in 2016-17?

No, they don’t meet it. They are pushing the states, saying ‘you borrow, we will see later, after 2022, you can repay your borrowings from those [cess collections].’ If it is a question of only borrowing – why put that burden on states?

In principle and the form of the commitment which was made was that of compensation, not borrowing. I don’t think both the proposals are in line with the spirit of the commitment, or appropriate for the fiscal management of state finances at this time.

I understand that states have been given seven days’ time. They are sovereign and will come back with whatever they think is most appropriate, but I think they should come back by saying, ‘there is a third option – you should borrow, provide us the compensation, and you repay it later.’

With all sides here finding themselves stuck in a narrow place due to the perceived structural limitation of the framework – what other revenue opportunities can be found, particularly at the state level? As you said – increasing rates on any form of taxation isn’t something that a government would want to do in this economic climate when the attempt is to let economic activity get back on its feet. How do states go about repairing their finances?

These are difficult times, there are no easy revenue options available. In fact, the states would have to do further revenue sacrifice to give a boost to economic activity. What you saw Maharashtra do in bringing down the stamp duty on real estate transactions to 2% – that is an effort so that real estate, housing, and economic activity revives and the state is prepared to sacrifice its revenue. Some more states may follow, in ways to give a boost to their economies, and do other things that would mean either sacrificing revenue or increasing expenditure by providing subsidies or other support mechanism. So, states have additional responsibilities and expenditure commitments. To do that, they may have to undertake additional borrowing. At such a time, why burden them further on what was a solemn commitment?

On the same day that Maharashtra made that stamp duty move, that state’s chief minister made comments that seemed to convey some loss of faith in GST as a collaborative project and idea. In a conversation with some other chief ministers, the Maharashtra CM wondered if the ‘old tax regime was better’.

What does it say about the health of the GST regime if a key stakeholder like the chief executive of the biggest state economy in the country is wistfully yearning the pre-GST days?

States lost a lot of sovereignty when the GST regime came in. They lost the power to decide on rates and several other things. But GST was nationally required. You can’t have 28 different rates on the same commodity because it is separate incidence of taxes. There was enormous mutually-destructive competition in terms of deciding rates. That was a bad system. But certainly, states lost a lot of authority.

Now, if the alternative system that was designed in the country does not seem to be giving them even that much revenue which they were realising in the old regime, it is understandable that somebody wistfully thinks that the old regime was better.

These are, in my judgment, short-term reactions to a desperate situation. But that’s not the most appropriate solution.

We must continue to have this uniform GST system for this country. The biggest stakeholder in this is the central government, which should be taking two steps forward, like what it did in 2016 to bring everyone on the table to make commitments. Why would, in normal circumstances, central government have to assure compensation to the states? When you merged and brought a uniform national law, at that time, it was expected that overall the nation would gain but there were some losers and some gainers [among states]. Therefore, if the central government provides a guarantee and assurance, the guys who would lose will come on board and agree to adjust their economy in a period of five years.

Nobody had thought that the envisaged gainers of this system would also lose, and that everybody would lose.

So, today, if the centre doesn’t go two steps forward to help the states and keep them on the GST bandwagon, this kind of reaction that you heard from that chief minister might escalate. The states might want ask ‘what are we gaining out of this system, better abolish it’. But that’s not in the wider national interest. Even from that perspective, the central government should take the decision and say ‘all right, you are suffering, we will borrow, and provide you compensation, and then we will recover this after 2022’.

In fact, that would be a better deal for the central government too, because now the states are likely to say that they are likely to lose even after 2022 and demand for the compensation cess to be extended for another five years. So while a 14% compounded growth rate is impossible to keep meeting, states might ask for a five-year extension of the cess with a 7-8-10% growth rate. That would be a justifiable reaction from the states’ side. To prevent the states from asking for this kind of change to the agreement and deal that is in place, the central government should not force them to borrow right now and say ‘the law is that if you can’t have the compensation cess, we are not obliged to provide it.’

There is the technical matter of the nature of the borrowing if the states are asked to do it. The way that the union Finance Ministry worded it, saying the borrowing would be with a ‘special window’… ‘in consultation with the RBI’… does that get seen as borrowing from the RBI, and not the market? If it is so, does it imply direct monetisation?

Direct monetisation, in our country, has not been done for the states, it’s only been done for the centre. I don’t think that anybody is envisaging a special window in the form of RBI subscribing to the state government papers. What it would mean is that RBI would facilitate it. To all states, the manager of the issue is also the Reserve Bank. I don’t think there is a problem in the subscription of states’ papers. That’s not the case at all. You can have additional borrowing and the paper would be subscribed. Therefore, that’s not the issue, it’s more fundamental… of saving the system of GST and doing all that is required to reform and rethink it to ensure that the GST delivers a positive growth rate in revenue. Even the central government’s revenues are suffering in post-GST times. So there must be something fundamentally wrong in the GST architecture.

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