GST Compensation to States: A Legal Responsibility of Centre or Grants-in-Aid?

(GS 3, Economics, The Hindu, Indian Express)

News/Context: On July 15 and October 7, the Centre had released Rs 75,000 crore and Rs 40,000 crore, respectively, to the states. With the release of funds on 28th Oct, the total amount has reached as back-to-back loan in-lieu of GST compensation is Rs 1.59 lakh crore.

The Centre on 28th Oct released the balance Rs 44,000 crore to states as loan to compensate for shortfall in Goods and Services Tax (GST) collections, taking the total amount to Rs 1.59 lakh crore this fiscal. These funds are in addition to normal GST compensation being released every two months out of cess collection.

It is expected that this release will help the states/UTs in planning their public expenditure among other things, for improving health infrastructure and taking up infrastructure projects.

The 43rd GST Council meeting on May 28, 2021, had decided that the Centre would borrow Rs 1.59 lakh crore in 2021-22 and release it to states and UTs with legislature on a back-to-back basis to meet the resource gap due to the shortfall in compensation, on account of inadequate amount collected in the GST compensation fund. This amount is as per the principles adopted for a similar facility in 2020-21, where Rs 1.10 lakh crore was released.

Let’s Understand the issue first: When GST was implemented in 2017, it came with the constitutional amendment. The powers of Centre and States of imposing and collecting indirect taxes, which were given by the constitution were amended. Earlier the centre was collecting the taxes on the production of goods (Excise duty) and Services (service tax) while states were having the power of collecting taxes on distribution or selling of goods ( sale Tax/VAT). But with the rollout of GST in 2017, these powers of centre and states were gone and a new system of GST was established, in which all existing taxes levied during the process of production (excise duty) and distribution (sale tax/ VAT) of goods and services and some other (not all) cesses and surcharges (tax on tax) were merged and renamed as GST.  Now say if 1000 as GST is collected then 500 will be going in the hand of the state in name of SGST and 500 will go to the centre in the name of CGST. With this, say, earlier states were getting 600 in total from Sales tax/ VAT. So in the said example actually States are having losses (of 100) in the new GST system. To avoid this the  GST (Compensation to State) Act, 2017 was enacted which has provisioned the Centre to  compensate states for losses for five years. As per the Act tax collection to be considered as 14% more than what was collected the previous year for every States. Anything less than this will be considered a loss to the state. As per the GST (Compensation to State) Act, 2017 Centre could  levy an extra compensation cess (extra burden on people). This extra burden (in the form of compensation cess) was levied for the said purpose from 2017 to 2022 earlier, which is now extended till 2026. The States these days were complaining that a huge amount of compensation is due on centre. And this is one of the major reasons for extending the compensation cess for more four years till 2026. 

The funding support comes at a time when many of the states are strapped for cash. While the Central government’s tax collections have become buoyant due to sharp spike in direct tax mop up, many states are on a weak revenue position.

Covid has impacted states disproportionately and many of them are now hard pressed for funds. Funding is essential at state levels to step up capital expenditure and infrastructure creation.

The move is expected to cool off yields in upcoming bonds auctions by states. The early release of the balance amount of the back-to-back GST compensation loan to the states will help them to plan their expenditure in H2 FY2022, avoiding a bunching up at the end of the year. Moreover, it should help to compress the size of the SDL (state development loan) auctions in the immediate term, modestly cooling yields.

On July 15 and October 7, the Centre had released Rs 75,000 crore and Rs 40,000 crore, respectively, to the states. With the release of funds on Thursday, the total amount has reached as back-to-back loan in-lieu of GST compensation is Rs 1.59 lakh crore.

The Rs 44,000 crore being released now is funded from the Government of India securities issued in the current financial year. These securities have a tenure of 5 years and are issued at a weighted average yield of 5.69 per cent. No additional market borrowing by the Central government is envisaged on account of this release.

Highest amount of Rs 5,010.90 crore has been issued to Karnataka, followed by Rs 3,814 crore to Maharashtra, Rs 3,608.53 crore to Gujarat, and Rs 3,357.48 crore to Punjab, among others.