GST: Centre backs off, compensation cess extended beyond 2022

Union Finance Minister Nirmala Sitharaman backed out from a full blown battle with the states over her refusal to pay in full the compensation that is due to them for the shortfall in collections from the ill-fated Goods and Services tax (GST). At the marathon meeting of the GST Council on Monday (October 6), which ended abruptly and inconclusively, Sitharaman announced that the Centre would pay the states a sum of ₹1.38 lakh crore, the expected shortfall in the current year.

In August, Sitharaman cited the COVID-19 pandemic’s impact on the economy as “an act of God”. She implied that since the plunging GST collections in the current financial year were not the making of the Narendra Modi government, the Centre ought not bear responsibility for compensating states for the shortfall in their share of the tax.

However, in a stormy 8-hour long meeting of the Council on Monday, which was apparently brought to a sudden close much to the chagrin of several ministers and bureaucrats attending the session, Sitharaman backed out from escalating the conflict further. In fact, adopting a conciliatory tone, a sharp contrast to her earlier strident demeanour, she dramatically announced that a sum of ₹20,000 crore would be released before midnight! This refers to the amount collected under the compensatory cess — levied on “sin” and luxury goods — during the current financial year.

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United front of states

According to Kerala Finance Minister Thomas Isaac, ten states — Bengal, Kerala, Punjab, Delhi, Jharkhand, Chhattisgarh, Telangana, Andhra, Rajasthan, and Puducherry — were ranged against the Centre on the contentious issue. Three states in particular — Kerala, Bengal and Punjab — have been vehemently opposed to the arbitrary denial of compensation for shortfall in GST collections. They have also opposed Sitharaman’s insistence that the shortfall be met through their own borrowings from the market. Instead, they have retorted that since meeting the shortfall is the Centre’s binding commitment, it, and not the states, ought to borrow to compensate them. In fact, the states managed to force the Centre’s hand on Monday by forcing it to extend the cess beyond its current five-year tenure, which is set to expire in 2022.

In August, Sitharaman said the GST collections in 2020-21 are likely to fall short by ₹3 lakh crore. Since collections of the cess were likely to amount to just ₹65,000 crore, it would leave a huge gap of ₹2.35 lakh crore. She ingeniously used the Act of God argument to attempt a fine distinction between a “normal” shortfall and one that arose from extraordinary circumstances — the COVID-19 pandemic in this case — to suggest that the Centre would only partially fill this yawning gap. She suggested that the Centre was only liable to the tune of ₹97,000 crore, implying the rest, arising from the Act of God, to be ₹1.38 lakh crore, for which the Centre was not liable.

Nirmala Sitharaman’s acceptance of the tab for ₹1.38 lakh crore marks a complete backtracking of her earlier position. It is an acceptance that there is no way the Finance Ministry could back off from its promise — made before the GST came into existence in 2017 — that the Centre would compensate states for shortfall that were based on normative estimates of the actual growth in tax collections in individual states.

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Nirmala Sitharaman had also issued an ultimatum to states asking them to opt for one of two borrowing plans in order to address their revenue shortfall. Clearly, the unified phalanx put up by the states has backfired on the Finance Minister. states have refused to accept a borrowing plan that would stretch their already beleaguered finances, especially as they battle the pandemic.

Although Sitharaman told reporters after the meeting that that 21 of 30 states and Union Territories had accepted the loan option offered by her, this was contradicted by Thomas Isaac who claimed 10 states had clearly asked the Centre to borrow to meet its obligations to them.

A hasty retreat

In fact, some states sought a vote on the issue at the Council, which prompted the Finance Minister to back down from a confrontation. It is obvious that she desperately sought to avoid a vote because she knew the numbers were loaded against the Centre. Desperate to avoid serious loss of face, Sitharaman scheduled another meeting on October 12 to sort out the pending issues.

Participants at the meeting — among them senior ministers and bureaucrats from the states — took umbrage at the manner in which a Union Government bureaucrat, Finance Secretary Ajay Bhushan Pandey, pulled the plug suddenly on the meeting even in the presence of the Finance Minister. If this did indeed happen, it boggles the imagination to think how a bureaucrat, acting on his own, could shut down proceedings without bothering to elicit a consensus on the proceedings.

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Revealing her desperate bid to avoid further conflict she also agreed that the shortfall, which was initially estimated at ₹97,000 crore, would be raised to ₹1,10,000 crore. The earlier estimate was based on a 10 per cent growth in revenues in the current year, against a target of 14 per cent growth in revenues. The states had contested this estimate, arguing that the gap in collections should be calculated on the basis of a more realistic 7 per cent growth in revenues in the current year. Nirmala Sitharaman’s acceptance of this demand of the states on Monday marks another significant retreat.

In recent days, the passage of the three farm bills under controversial circumstances has also raised the ire of state governments, which have alleged transgressions by the Centre into areas that are Constitutionally mandated to be within their remit. The GST issue has pitchforked Centre-State financial relations centerstage during the pandemic. States, which have done the bulk of the heavy lifting in fighting the pandemic and its economic consequences, have complained that heaping additional borrowing costs on them would leave them extremely vulnerable.

Nirmala Sitharaman’s retreat on Monday is an admission that the Centre is under pressure. Events in the next few weeks will show whether the states have been able to decisively wrest a better deal in the battle over GST.