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Why Centre’s Stance on GST Compensation is Utterly Bizarre

Prabhat Patnaik

When the Goods and Services Tax (GST) was introduced, and states virtually gave up the power to levy indirect taxes which they had enjoyed under the Constitution, the Centre had solemnly promised that it would compensate them for five years for any revenue shortfall arising from the shift to GST.

The shortfall was to be assessed relative to what revenue should have been, assuming a 14% rate of growth. It is this promise which had persuaded many states to fall in line behind the GST. And Parliament had enacted the GST (Compensation to States) Act 2017 to legalise this promise.

The, GST, however has been singularly unsuccessful in garnering revenue, partly because of its own infirmities and partly because of the slowing down of GDP (gross domestic product) growth. Likewise, the GST cess, which is supposed to finance the compensation payment to states, has also failed to garner adequate revenue. While the states’ revenue growth, therefore, has been sluggish and hence the need for compensation, particularly large and urgent, the fund out of which such compensation is to be paid has also shown sluggish growth.

The logical course for the Centre to tide over this shortfall would have been to borrow, or to raise taxes from other sources, and then transfer these additional resources to state governments as its compensation payment.

But, instead of keeping its promise, the Centre has simply reneged on its compensation payment. The problem began in August 2019, but has assumed serious proportions in the current fiscal year, owing to the pandemic. The pandemic has drastically reduced GST revenue, and with it the states’ share, while greatly increasing their expenditure requirements.

The compensation amount for 2020-21 is estimated at Rs. 3 lakh crore, of which only Rs. 65,000 crore would be paid out of the cess levied by the Centre. As for the remaining Rs. 2.35 lakh crore, the Centre simply refused to pay it. In the August 27 meeting of the GST Council, it just asked the states to borrow this amount. It has offered two different options to state governments, but they both amount to making the states borrow.

This is an utterly bizarre stand for two very obvious reasons: first, it violates not just a solemn promise given by the Centre, but an Act of Parliament. It is on this basis that the states had given up their constitutional rights and agreed to enact constitutional amendments paving the way for the introduction of GST. The Centre is now reneging on an obligation that underlies the entire new constitutional arrangement. Second, there is not an iota of economic logic behind the Centre’s stand.

Whatever “harm” larger borrowing by the Centre can do to the economy, will be done equally if states do the borrowing instead. In fact, by asking the states to do the borrowing, the Centre has already conceded that Rs. 2.35 lakh crore of borrowing on this score can be safely done and the proceeds injected into the economy as additional expenditure. But then, why can’t the Centre do this borrowing and hand over the proceeds as GST compensation to the states?

This will have two obvious advantages: first, and most important, constitutional proprieties would have been observed with no question of any reneging involved. And second, with the extensive taxation powers that the Centre has, its debt is perfectly safe, where no fears of default need arise. The Centre, in short, can borrow with impunity unlike the states.

The Centre, however, has put forward two arguments in favour of its suggestion, both of which are baseless. The first is that the pandemic that has caused a massive shortfall in GST revenue is an “Act of God”, for which the Centre cannot be held responsible.

Now, such provisions regarding lack of responsibility in the event of the occurrence of an ‘Act of God’ characterise private contracts, where each party to the contract, in a typical capitalist manner, attempts to maximise its gains. It cannot characterise the contract between two tiers of popularly-elected government in a democratic society.

Finance Minister Nirmala Sitaraman’s invoking an ‘Act of God’, therefore, reduces relations between different tiers of government in a federal polity to the level of a contract between two private parties. This is not only bizarre, but constitutes an act of supreme irony on the part of a government that keeps talking of “cooperative federalism”.

The second argument of the Central government is that if it borrowed to pay GST compensation to states, then the cost of its borrowing would go up, which would be harmful for the economy as a whole. On the other side, if the states borrowed, then such an increase in the cost of borrowing presumably would not happen. This argument, however, is completely without any basis.

Besides, there is absolutely no reason why the Central government should go to the market to raise this loan. Since, by its own reckoning, this borrowing has been necessitated by “an Act of God”, it can easily ask the Reserve Bank of India to lend this amount to it at the Repo rate, i.e. the rate at which the RBI lends to the banking system.

If the entire sum of Rs. 2.35 lakh crore is borrowed at the Repo rate from RBI, then this would not even entail an increase in the amount of Reserve Money, i.e. currency in the economy, which is the monetary liability of the RBI, by this amount.

A simple example will clarify the point. Suppose that at the margin, the people at large hold no currency but only bank deposits. When the Centre gives the states Rs. 100, say, as GST compensation, then all of it will come back to the banks as deposits. The banks can extend loans with this additional resource.

Now suppose the cash-reserve ratio of banks is 10%, and the “worthwhile” demand for credit (from the point of view of banks) is Rs.300, then the banks will give out Rs. 300 as credit, for which they would need to hold Rs. 40 as cash reserves (10% of total liabilities of Rs. 400). The remaining Rs. 60 cash which they possess will be used by them for buying government securities from RBI. So, the reserve money in the economy would have increased by only Rs. 40, even when the Central government has borrowed Rs. 100 from the RBI.

The Centre’s borrowing from the RBI at the Repo rate would have two further advantages. First, by putting additional resources in the hands of the banks (who do not have to borrow these resources from the RBI) it enlarges bank credit in the economy compared with what it would otherwise have been; and second, the interest rate in the economy would be lower because of this injection of liquidity. Since the Indian economy is currently faced with a serious recession, both these should be considered desirable developments.

In other words, the Centre’s borrowing from the RBI at the Repo rate to meet its GST compensation obligations, kills several birds with one stone. First, it enables the Centre to fulfil its constitutional obligations enshrined in the 2017 Act. Second, it does not subject the state governments to any strain and hence strengthens the federal structure. Third, it helps the economy to overcome the recession better, by nudging it towards a lower interest rate and an easier state of liquidity.

But, the Narendra Modi government, with its limited understanding of economics, and even more limited sympathy towards the states, cannot see these obvious points.

At the GST Council meeting, all major states, with the exception of two Bharatiya Janata Party-ruled ones, rejected the Centre’s proposal that the states should borrow to make good the shortfall in their GST compensation. The government of Kerala in particular has come out strongly against this proposal. It is imperative that the states are paid what is their due, if the federal structure of the polity is to be preserved.

(Prabhat Patnaik is Professor Emeritus at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. Article courtesy: Newsclick)

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Kerala’s Stand on GST Compensation Deserves Full Support

Bharat Dogra

While addressing an important press conference on 29 August, the Finance Minister of Kerala Thomas Isaac said that the Centre must take out loans in order to fulfil its commitment to pay the states their due GST compensations. This, Isaac has forthrightly said, is a rejection of the Centre’s position, which it has made clear at a recent GST Council meeting. The Centre has said that the states must do the borrowing to resolve the financial crisis caused by non-payment of GST dues, and that the Reserve Bank of India would be part of the process.

Isaac has already said that his proposal has the support of not only the Chief Minister of Kerala Pinarayi Vijayan, but of several other chief ministers. This was confirmed at the GST Council meeting, at which several states said that the Centre must be the one to borrow funds and disburse it among states. Isaac has also said that Kerala will take the lead in trying to build a consensus among as many states as possible on this issue.

One widely-discussed aspect of the resource crunch of recent times is that the Union government has not yet paid the constitutionally-mandated Rs.1.5 lakh crore GST compensation due to states for April to July in current fiscal. The total shortfall in GST compensation to states is officially estimated at Rs.2.35 lakh crore, of which Rs.97,000 crore is estimated on account of “GST implementation” and the remaining to Covid-19 related factors.

Several state governments have opposed the denial of funds as they are guaranteed to them in exchange for accepting the GST agreement, which redraws the earlier federal arrangement. The denial of dues by the Centre has been called unconstitutional by Isaac. Similarly, the Finance Minister of Punjab Manpreet Singh Badal has said, “In the seventh meeting of the GST Council the Chairman observed that it was the constitutional commitment of the central government to provide cent per cent compensation…Cooperative federalism has been transformed into coercive federalism.”

Kerala’s position is likely to garner widespread support as states now have to bear a number of additional responsibilities while their revenue position has declined significantly. This is due to a number of factors, of which one of the most important is that the Centre has not fulfilled its GST-related obligations. States had given up some of their autonomy for the greater common good of a unified tax system sold by them to the Centre, and because they were assured that their losses would be compensated for losses in the early years. Now that the compensation has not come through, the ability of states to meet their welfare and development obligations, and even to meet regular administrative functions, are likely to be very adversely affected. This is an issue with massive implications especially for ordinary people, particularly the poor.

Many states have hardly any space for increasing capital expenditure, while some have reported problems in making salary payments. The present crisis comes on top of the already worsening debt situation of many states. The debt burden of state governments has doubled during the last five years, and is estimated to be around Rs.50 lakh crore. The Reserve Bank of India has expressed serious concern over the fast-increasing debt.

In addition, the Union Finance Minister Nirmala Sitharaman has described the ongoing viral pandemic as an “act of god”. This is already being questioned and even lampooned. The reason is that the minister is conveying that the pandemic is beyond human control, and therefore the government cannot be held accountable for any disruptions caused by it. This is clearly not a rational view and lacks scientific basis. The causes of any pandemic are within the ambit of scientific explanation and its rapid spread even more so. Calling it an “act of god” amounts to denying the need for rigorous and detailed scientific inquiries into it causes and the nature of its spread.

Is the description of the Finance Minister the accepted official view of the government of India on the pandemic? If it is not, then this should be clearly stated by the Centre.

Even if we accept for the sake of argument that the pandemic was beyond human control, we still have to reckon with the fact that different responses to Covid-19 have led to very different outcomes on both economic and social life in different countries, even regions within the country. This is due to the very important factor of policy and how it was wielded to tackle the spread of the virus.

One interpretation of the phrase “act of god” is strictly legal. It is as a clause used in private contracts to secure indemnity or exemption against fulfilling the contracted terms in case events beyond control take place. However a legality relating to private contracts cannot be applied to democratic federal relationships, nor to constitutional obligations. As Badal has said, “The constitutional framework that ushered in the GST does not provide an escape clause for ‘Acts of God’.”

In some countries, the distress caused by Covid-19 remained moderate due to their better healthcare management while in others, including India, the disruptions are among the worst in the world.

In India’s context, we need to ask the Centre whether the prolonged lockdowns it imposed, which had millions of migrants take extremely painful journeys on foot were based on evidence and rationality. Clearly they were not, as the highly-restrictive conditions imposed by the lockdown proved counter-productive.

For all these reasons, and in the interest of justice and trust-based federalism, the government cannot use an imagined act of god as a reason to not meet previously-settled obligations to states on GST. The states are heavily burdened by the tendency of the Union to shore up revenues by imposing cess upon cess, whose proceeds are not shared with states. It is equally telling that the Centre is not exercising a number of other options to raise revenues—such as increasing tax on the richest persons, including a wealth tax, and the biggest corporates. In these times of economic difficulties, the government must remember its forgotten promise of bringing back billions of rupees stashed in foreign accounts.

Last but not least, the Centre can improve its finances by dropping wasteful projects, as can many state governments which have saddled themselves with wasteful and ecologically and socially disruptive schemes and plans. Many such projects are being pushed whose benefits accrue to narrow interest groups at the cost of the exchequer and citizens.

India has to think not only of this fiscal year but of coming years too. If the burden of borrowing is placed on states, it will merely worsen their position in years to come. The Union has more options available to raise revenues, and so the Kerala government and its Finance Minister must be heard: the Centre should take out a loan and provide GST compensation.

(The writer is a freelance journalist who has been involved with several social movements. Article courtesy: Newsclick.)

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Tamil Nadu Gasping for Funds as GST Compensation Remains Elusive

Neelambaran A.

The coffers of many state governments have run dry since the past several months with the pandemic-induced lockdown ruining the economy and unpaid GST compensation by the Centre due for several months. The implementation of Goods and Sales Tax (GST) has literally snatched away the rights of the state government in levying taxes. As a result, several state governments are left at the mercy of the Union government for revenues.

The Tamil Nadu Chief Minister had no option but to shoot a letter to the Prime Minister demanding the payment of compensation for the revenue loss. The CM referred to the 101st Constitutional Amendment Act and GST (Compensation to States) Act, 2017 and reiterated that the Union government must mobilise funds and lend to states. The letter has also demanded that the states get the full dues in the current year itself.

‘GoI Has Moral And Legal Obligation’

The state government has witnessed a continuous increase in the revenue deficit, which reflected in the recent budget as well. “The net outstanding debt by the end of March 31, 2021, is expected at Rs 4,56,660.99 crore and debt to GSDP ratio will be 21.83%, which is well within the norm of 25%”, said state Deputy Chief Minister and Finance Minister O Panneerselvam in his budget speech.

Given the large deficit, the TN government has been waiting for its share of the compensation, but to no avail. “Our stance has consistently been that the government of India has a moral and legal obligation to pay the compensation for the shortfall in GST collections,” the CM wrote.

Venkatesh Athreya, economist and professor told NewsClick, “The state governments were forced to accept the GST on the condition that compensation for five years would be paid. The GoI must take loans and distribute to the state governments instead of forcing them to take loans.”

The letter also reminded the Centre that ‘no compensation has been released for the shortfalls in collections since April 1, 2020. As on date, a total sum of Rs 12,250.5 crore is due to Tamil Nadu as compensation for shortfall in GST collections, of which Rs 11,459.37 crore has accrued from April to July 2020’.

‘FM Suggestions Unacceptable’

Referring to the Finance Ministry’s suggestion on the state government to raise loans from the open market, including the Reserve Bank of India (RBI), the CM wrote, “I am very concerned about the two options that have been offered to states after the GST council meeting held on August 27, 2020.”

The state government in the GST Council meet has insisted that the Union government could mobilise resources and lend the funds required to the GST compensation cess fund and that loan could be serviced through an extension of the GST cess for few years beyond 2021-22.

“The Union government asking the states to take loans from the open market defies logic. The government is behaving like a money lender and violating the sovereign guarantee, which goes against the Constitution. The economy has not been ruined by the ‘act of God’, but by the terrible policies of the Modi government,” Athreya said.

‘Permit Additional Borrowing’

The government relies largely on income from sale of liquor through the state-run Tamil Nadu State Marketing Corporation (TASMAC) and the Value Added Tax (VAT) on petroleum products. The lockdown has restricted these incomes, leaving the government gasping for funds. With the other incomes squeezed on the implementation of the GST, the autonomy of the states, too, has been affected.

The CM has also demanded borrowing one-third more compared with the 2019-20 levels and an untied special grant of Rs 1 lakh crore to be released to all the states as budgetary support, in addition to other specific grants.

The additional spending due to the COVID-19 pandemic has also hit the state governments. The state has claimed to have invested around Rs 7,000 crore to upgrade the health facilities and other related needs. The demand to sanction funds for the state from the PM-CARES has also yielded no results.

‘Revisit GST Structure’

The country has been witnessing a steady drop in growth since the last quarter of 2018-19. With continuous attacks, including the demonetisation in 2016, followed by the implementation of GST next year, the economy has been shattered.

“It is highly pathetic to recollect that this government compared the introduction of GST to the freedom struggle. “The ham-handed design of the GST has proved to be a miserable failure. The implementation has also affected the federal structure of the nation and dented the autonomy of the states. It is time to rethink the GST rates as well,” Athreya said.

The economic policies pursued by the Narendra Modi government have affected the exchequer of the states, resulting in the hampering of the welfare measures for the poor and needy. The large claims of ‘One Nation, One Tax’ have dented the autonomy of the states and the federal setup, while the positive outcomes are yet to be seen, he said.

(Article courtesy: Newsclick.)

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In another article published in Newclick, GST Will Implode States; Himachal is Already Feeling the Heat, Tikender Singh Panwar adds (extract):

Himachal Pradesh has already started feeling the heat of this decision. Even the state minister (BJP) in the GST Council had asked the Centre to compensate the state adequately.

The option of borrowing placed by the Centre is not only erroneous but also disastrous for a small state like Himachal Pradesh. The total liabilities of the state, including public debt and other obligations, have soared past Rs 50,000 crore (Rs 50,772.88 crore). With such a huge debt burden, further borrowing either from the Reserve Bank of India (RBI) or from the market would turn the state into a mere adjunct of the financial institutions.

There are numerous stories on the relationship between money lenders and recipients and invariably in all of them, the debtor is ruined. Shakespeare’s play, The Merchant of Venice, is a vivid reminder of the reality of a debt trap. These neo-merchants, who are advising the states to borrow, should realise that once caught in a debt trap, the states would never be able to come out.

Let us look into the actual situation in Himachal Pradesh and how it may impact people. After the shift from VAT (value added tax) to GST, Himachal had projected a revenue generation of Rs 3,855.14 crore for 2020-21. This amounts to almost 42.41% of the total tax revenue to the state. In the absence of this transfer from the Centre and in a situation where the transfer has not been made since March, the fiscal health of the state would be seriously impacted.

The other major revenue sources that the state envisioned in the budget proposal are from excise duty, mainly on the sale of liquor, and VAT. This amounts to Rs 1,625.37 crore (19.67%) and Rs 1,491.39 crore (18.54%), respectively for excise and VAT.

There has been a massive shortfall in all these three heads of the state’s own revenue–state GST, excise and VAT–due to the unilateral lockdown announced in the country since March 25 this year.

The hospitality industry, one of the major sectors contributing to excise, lies shattered. Similarly, VAT revenues fell considerably. Production of cement and sale of cars are the only two sectors that contribute to the state’s GST. However, owing to the lockdown, there was little demand for cement as well. From March to June, there was hardly any revenue even from these two sectors. It is only in July and August that nearly Rs 300 crore per month GST was generated in the state.

A state with a huge liability could survive with a revenue deficit grant as per the 15th Finance Commission, which is also going to end this year. This amounts to nearly Rs 11,400 crore.

“This is a grave situation,” said a retired bureaucrat, who was handling the financial department in the state government for a long period. The salary component liability in the state for 2020-21 is Rs 44,545.05 crore, along with pensions of Rs 7,266 crore and the interest payment on loans borrowed amounting to Rs 4,931.92 crore. These three combined constitute 51.49% of the total expenditure in the state—salaries make up 26.66%, pensions 14.79% and interest payments 10.04%.

The total debt has already reached 42% of the state’s gross domestic product or GSDP and the projected GSDP of Rs 1,82,020 crore looks unachievable.

Agriculture in the previous year showed a negative growth of 4% and the major sector contributing to the growth of the state’s economy was services, which too has been severely hit. There is currently an estimated shortfall of nearly 20% in revenue earnings of the state for 2020-21.

The fiscal deficit was estimated to rise from the budgeted 4.35% to 6.42% of the GSDP, and if the state is asked to borrow more, it would make the situation worse. The state may have to borrow nearly Rs 5,000 crore to ensure that it is at least able to disburse the salaries of its employees on time. Already a few departments, like tourism and transport, have been unable to pay salaries for the last three to four months.

Who is going to pay for the huge debt that the state is accruing? Or will the state government one fine day say that it is ready to cut the salaries of its employees by a certain percentage, as it is unable to disburse these?

The challenges faced by Himachal Pradesh are clearly beyond its capacity to resolve. Instead of blindly accepting the firmans of the Centre, the BJP-led state government should vociferously raise its voice, and akin to the past, must demand ‘special category status’.

Along with other states like Kerala, Rajasthan, and Maharashtra, Himachal Pradesh should also raise its voice against the Centre’s GST dictum and it to act according to the Act. It should remember that the government in office is a mere custodian of the rights of the state and its interests are the people. Governments come and go; the interests of the state and its people are supreme.

Note: Figures mentioned in the story are from Himachal Pradesh’s Economic Survey and the state budget of 2020-21.

[The writer is former Deputy Mayor of Shimla, Himachal Pradesh.]