How Centre flouted GST law, diverted ₹3.1 lakh crore meant for states

In the brouhaha over the Goods and Services Tax (GST) rate cuts, few reckon or realise how the Centre has been violating its own GST (Compensation to States) Act of 2017 on multiple fronts, layering data to hide facts and choking states for revenue.

The most glaring one is misappropriation of GST Compensation Cess, which the GST law brought in for “the purpose of providing compensation to states for the revenue loss arising on account of implementation of the goods and services tax”. States gave up their rights to nine indirect taxes in 2017, which were subsumed into the GST (along with the Centre’s eight indirect taxes).

Misappropriation of Rs 3.1 lakh cr

The GST law specifically provides that the proceeds of the cess “shall be credited to a non-lapsable Fund known as the Goods and Services Tax Compensation Fund” and would be utilised only for the purpose of compensating states.

But the Centre’s budget documents reveal it misappropriated Rs 3.1 lakh crore of the cess and diverted it to the Consolidated Fund of India (CFI) during FY18-FY25 (ER) — instead of depositing it into the specified compensation fund.

This misappropriation happened in six out of the eight fiscals of FY18-FY25 — except for FY21 and FY23.

The following graph maps these misappropriations, using data from the Centre’s budget documents.

In the graph, the red bars represent the cess collected and the yellow bars funds withdrawn from the GST Compensation Fund to pay compensation to states.

Inflow-outflow mismatch

Had the Centre not violated the GST law, both the bars would have been equal in size, reflecting that the entire amount collected through the cess was given to states as compensation. But that clearly is not the case.

To understand the graph better, here is how the normal fiscal math works.

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The proceeds of GST cess — like that of any cess which are meant for very specific purposes, non-lapsable and can’t be used for any other purpose — first flow into the CFI and from there it into the specific fund every fiscal.

In any particular fiscal, if and only if all the GST cess collected (red bars) flows into the GST Compensation Fund (inflow), then the outflow from this fund (yellow bars) will match. (Caveat: The outflow from the fund is, therefore, marked with a negative sign (-), but for the purpose of better understanding, this graph uses positive values).

But the inflow and outflow don’t match for any of the eight fiscals. In six fiscals, the cess inflow (collected) is more than the fund outflow and in two other cases, the reverse is true.

In the first fiscal of FY18, the gap between the inflow (cess collected) and outflow (from the fund) was Rs 21,466 crore and in FY19, it was Rs 25,806 crore — taking the total to Rs 47,272 crore. That is, Rs 47,272 crore of the GST cess collected was retained in the CFI — not passed on to the GST Compensation Fund.

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This is a violation of the GST law of 2017. But such violations are normal in recent years (more on that later).

When CAG caught Centre

The Comptroller and Auditor General (CAG) of India called out this “short-crediting” or deliberate misappropriation as “a violation of the GST Compensation Cess Act, 2017” in its report tabled in September 2020 and elicited a promise that the Centre would put back the money in the designated fund.

The Centre did the exact opposite in the next fiscal, FY20, showing scant respect for the CAG, a constitutional authority set up to ensure accountability and checks and balances. That year, it misappropriated Rs 83,503 crore into the CFI — that is, it collected Rs 95,553 crore of cess but put only Rs 12,050 crore into the fund, retaining the rest in the CFI.

Also, it didn’t put back Rs 47,272 crore into the fund as it had promised to the CAG.

The same misappropriations can be seen in FY22, FY24 and FY25 also (see the graph).

Gross fiscal mismanagement

Why did the outflow from the fund exceed the cess inflows in FY21 and FY23?

Quite apparently, the Centre transferred money from the CFI to the fund.

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Both types of money flow — from the cess to the CFI and from the CFI to the fund — are gross violations of the standard fiscal management practices, not a simple accounting error or juggleries. Such a two-way movement of funds is breathtaking in its sweep.

During the pandemic lockdown of 2020, states asked the Centre in Parliament to pay them the GST compensation from the CFI — instead of borrowing from the Reserve Bank of India (RBI) to give it as a loan, as the Centre had declared by then.

Union Finance Minister Nirmala Sitharaman refused. She quoted Attorney General of India KK Venugopal to say that there was no provision in the law to compensate states for the loss of GST from the CFI.

It was around that time that the CAG’s report calling out the Centre misappropriating Rs 47,272 crore of the GST cess into the CFI was tabled in Parliament.

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That the Centre refused to pay GST compensation to the states and took loans from the RBI instead — in FY21 and FY22 — was another gross violation of the GST law. Here is how that came about.

Loans instead of compensation

The FM first told states at the GST Council that meet in Goa in September 2019 that the Centre was facing fiscal constraints and wouldn’t be paying the compensation. This was followed by an official communication from the GST Council to states in November 2019 (FY20). The threat was carried out in FY21 and FY22.

But the first threat of September 2019 was also the time when the Centre announced the corporate tax cut of Rs 1.45 lakh crore out of the blue — soon after the RBI announced (August 26, 2019) transferring Rs 1.76 lakh crore of surplus.

The previous high of RBI’s surplus transfer was mere Rs 0.66 lakh crore in FY15 and FY18. This ‘windfall gain’ went into underwriting the corporate tax — but not to pay states their legitimate right.

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The Centre borrowed Rs 1.1 lakh crore in FY21 and Rs 1.6 lakh crore from the RBI and gave it to the state as “repayable” loans. The Centre’s budget documents describe it as “back-to-back loans to states in lieu of GST Compensation shortfall”. The CAG report of August 2025 confirms that this was initially to be repaid by the states.

But then good sense prevailed. The Centre decided to repay the loans itself and amended the law in June 2022 to extend the cess from June 2022 to March 2026 for this purpose.⁵

This fact will come in handy in understanding how the Centre’s fiscal mismanagement is par for the course.

Arrears of compensations

The following graph maps the GST cess collected and the compensations given to states. Notice the mismatch here, too.

Also notice that the compensation paid to states continues into FY24 and FY25 — long after it ended on May 31, 2022. Further, budget documents show, it will continue in FY26 (BE) with a transfer of Rs 500 crore (out of the estimated cess receipt of Rs 1.67 lakh crore).

In fact, on May 31, 2022, the Finance Ministry issued a statement which said, “The Government of India has released the entire amount of GST compensation payable to States up to 31st May, 2022, by releasing an amount of Rs. 86,912 crores.”

This made the national headlines then, creating a mistaken notion that the Centre had fully paid the compensation right before the deadline.

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The mismatch is also because the loans the Centre took in FY21 and FY22 are not part of the compensation given to states presented in either of the graphs. The loans are given separately in the budget documents — called “back-to-back loans” or “B2B loans” — adding another layer of complexity to GST disclosures.

The GST data are layered in the budget documents. Different sets of data are given in the “budget at a glance” and the expenditure budget, none of which gives a complete picture. This also raises doubts about the accuracy of the Centre’s disclosures on GST cess and compensation.

4-year delay in compensation payment

The GST cess and compensation were to end in five years, by May 31, 2022 (from 2017), as it was expected that by this time new GST regime would have stabilised.

But as the earlier graph shows, the states continue to get “arrears” into FY25 and will get Rs 500 crore of the remaining in FY26 (BE).

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That is, for more than four years after the full amount was declared to have been paid.

This is another example of fiscal mismanagement that hits at the “cooperative federalism” the Centre has been showcasing. Prime Minister Narendra Modi called it the “best example” of cooperative federalism in 2018. Even the then Chief Justice of India DY Chandrachud hailed it the “classical example of cooperative federalism” in 2024.

Rampant fiscal mismanagement

Here is what the CAG’s 2020 report mentioned earlier had further said about the Centre’s mismanagement of cess.

It listed many such instances and said, “Audit observed, however, that out of the Rs 2,74,592 crore received from 35 cesses, levies and other charges in 2018-19, only Rs 1,64,322 crore had been to Reserve Funds/ Boards during the year and the rest was retained in the CFI. This included collections amounting to Rs 382 crore on account of 17 cesses abolished/subsumed in GST with effect from 1 July 2017, which were retained in the CFI.”

That is, 40 per cent of cess, levies and other charges were misappropriated in FY19 alone.

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R Ramakumar, who teaches at the School of Development Studies of Tata Institute of Social Sciences, Mumbai, listed many such misappropriations by the Centre that the CAG flagged in later years in a 2024 article about “disquieting features of vertical devolution of resources from the Union government to the states”.

These cases involved short-crediting or non-crediting proceeds from the Health and Education Cess, Madhyamik and Uchchtar Shiksha Kosh (not even formed), cess on crude oil and natural gas (not passed on), excise duty meant for Central Road and Infrastructure Fund (CIRF), Central Road Fund (CRF), Clean Energy Cess, Research and Development Cess, Swachh Bharat Cess, and others.