Nirmala's denial of GST funds to states, a Shylockian bargain

As the Indian economy lurches towards its worst-ever recession, Finance Minister Nirmala Sitharaman on August 27 invoked the “act of God” to deny Indian States what was originally promised to them when the Goods and Service Tax (GST) was rolled out in 2017. The denial of GST funds comes at a time when the states have borne the brunt of fighting the Covid pandemic.

At a meeting of the GST Council on Thursday Ms. Sitharaman virtually declared force majeure, a first for an Indian government. She made the rather fine distinction between GST revenues that have fallen precipitously because of the Covid-19 impact and the transfer of funds mandated by the pact with States that brought the GST.

Related news: Govt pegs GST shortfall at ₹2.35 lakh crore this fiscal

The overall compensation that is to be paid to the States during 2020-21 is estimated at about ₹3 lakh crore. However, collections from the cess that is meant to service this is expected to amount to only ₹65,000 crore, leaving a gap of about ₹2.35 lakh crore, according to Finance Secretary A.B. Pandey prior to the meeting.

Till date not a rupee of the compensation that is due to states in the current financial year has been paid.

The Finance Minister argued that of the total estimated shortfall — mind you, these are still estimates in a hugely uncertain Covid-ravaged economy — only ₹97,000 crore has been estimated to have arisen from the switch to the GST, which is what the compensatory mechanism was meant to provide.

The remaining shortfall according to the calculations of the mandarins in the Finance Ministry — a whopping ₹1.38 lakh crore — were attributed to the hand of God. How this break up of what was attributable to the act of God and to the act of the Finance Ministry was arrived at has been left to conjecture.

And, like a benevolent employer who helpfully “arranges” loans for distressed employees, Nirmala Sitharaman helpfully offered to talk to the Reserve Bank of India to get loans on less onerous terms from the market.

In fact, she offered a limited-time one-week offer of choosing from two options to states. The first option offers market borrowings to cover the estimated “loss” of revenue of ₹97,000 crore arising from the implementation of the GST regime.

Helpfully, the Finance Ministry offered to extend the cess on “sin” and luxury goods such as aerated drinks, cars, and tobacco behind 2022; how much of a help this would actually be is anybody’s guess in a Covid-haunted world where consumption has collapsed catastrophically.

The second option, if at all it may be termed so, allows states to borrow the entire projected shortfall — ₹2.35 lakh crore — from the market.

However, the catch is that the ceiling on borrowings, set by the provisions of the Fiscal Responsibility and Budgetary Management Act, would kick in, limiting the states’ ability to access market borrowings. In fact, Kerala Finance Minister T.M. Thomas Issac estimates that states would be unable to utilise at least ₹50,000 crore — one-fifth of what is ostensibly on offer — because they would hit the limits set by the FRBM.

Related news: Centre ‘morally bound’ to compensate states under GST: Bihar dy CM

Strangely, given that the matter that has been hanging fire for months, the Finance Ministry has given states merely a week to decide on which option they would prefer to exercise.

The provision for paying compensation to states was a central feature that enabled the Narendra Modi government to roll out the GST regime in 2017, less than a year after the disastrous demonetisation of November 2016.

It may be recalled that the compensation mechanism was the key carrot dangled before sceptical states who feared loss of autonomy over the last bastion in Centre-State financial relations. It provides an assured 14 per cent increase in revenues after implementation with the 2015-16 set as the base year. 

In order to assuage the fears of states that their revenues may decline because of GST implementation, the Centre agreed to a five year period in which States would be entitled to “compensation”. Nirmala Sitharaman’s unique and innovative interpretation of the pact threatens to undermine the GST regime’s very legitimacy.

Related news: GST Council meeting discusses revenue shortfall of states

Naturally, several states, particularly those ruled by the opposition, have taken umbrage. Kerala Finance Minister T.M. Thomas Issac has demanded “full compensation” as a “Constitutional right of the states.” He pointed out that constitutional provisions did not provide for the kind of distinctions made by Nirmala Sitharaman in the matter of determining the quantum of compensation due to the states.

Punjab Finance Minister Manpreet Singh Badal said the “solution” offered by the Finance Minister was not in keeping with the spirit of the constitutional provisions governing compensation due to the states.

Chhattisgarh Finance Minister T.S. Singh Deo said states were being “arm-twisted” to accept the solution offered by the Finance Ministry.

The beleaguered states have demanded that the Union government ought to have provided the compensation to the states upfront. The matter of mobilising resources to meet its commitment to states ought to have been its own burden instead of the states’.

It is not clear what fine art the Finance Ministry has used to estimate the shortfall arising from the “act of God” or how credible the GST revenue projections — and therefore the shortfall —  are.

Given that the States have had to do the heavy lifting in the wake of the pandemic, particularly since they have borne a disproportionate burden of the responsibilities of providing health care and relief.

A more sagacious approach would have paid heed to the massive burden of additional expenditure they have had to incur because of the pandemic.

The denial of compensation thus amounts to a double whammy — a sudden expansion of expenditure even as revenues have been throttled. The needless controversy threatens to undermine the very legitimacy of the GST regime, one that has had a chequered life so far.