Decoding the GST tussle between Central & State governments


3 min read
Decoding the GST tussle between Central & State governments

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Introduced in 2017, GST was a consumption-based tax. Meaning states with higher consumption figures were ideally expected to benefit more than producer states. Consumption based states were benefiting the most and producer states were left with limited options to earn as any state's major part of earning is 'Tax'.

The central government had came up with a solution and promised to compensate them until they could work out alternatives. For instance, a state’s tax revenue was expected to grow at 14% (from the base 2015–16) and then, if actual collection fell short of these projections, the centre promised to make up the shortfall.

Problem solved!

But, have you ever thought from where central government will compensate the states when their own finances is in such a bad shape? For instance, look at the way the pandemic has impacted centre's tax collection:

.. and India’s fiscal deficit has already breached the full-year target in April-July as the coronavirus pandemic continues to weigh on the government’s revenue. The gap between revenue and expenditure reached Rs 8.21 lakh crore, or 103% of the budgeted estimate. Centre's revenues are under great strain not just because of the pandemic but also due national security.

Why did the centre expect state tax revenues to grow at 14% when their GDP is contracting by whopping 24%?

As per data, In the current fiscal, the compensation requirement of states has been estimated at Rs 3 lakh crore, of which Rs 65,000 crore would be funded from the revenues garnered by levy of cess.

This leaves a shortfall of Rs 2.35 lakh crore. The centre has estimated that of this Rs 2.35 lakh crore, Rs 97,000 crore compensation requirement is due to GST rollout and the remaining 1.38 lakh crore is on account of the impact of Covid-19 on the economy.

Hence, it is in the collective interest of both centre and states, as well in the interest of the nation and of all economic entities not to do any avoidable borrowing at the Central level when it could be done at the state level.

So the finance minister finally confessed that the centre would not be able to make up the shortfall due to COVID. It’s as an 'Act of God'.

'Acts of God' is used in contract law to protect parties in a contract from circumstances that may arise outside of any one party’s control. For instance, insurance companies would not pay out vehicle insurance if the car is lost in an earthquake; if they had to do so for every car lost in the natural disaster, they would go bankrupt.

But what makes anybody think the Centre can bear this burden? After all, COVID has impacted not just state's tax collect but central government too.

Final Solution:

The Centre has outlined two proposals for states to make good on the shortfall, both of which involve additional borrowing by the states.

States could either borrow a sum of Rs 97,000 crore from the RBI (which, they calculate, is the shortfall solely due to the implementation of the GST), or borrow the entire sum of Rs 2.35 lakh crore. It would create, along with the Reserve Bank of India (the RBI), a “special window” for the States to borrow the sum of Rs 97,000 crore, which might involve lower interest rates. It is not clear whether this window would be available for the entire 2.35 lakh crore, which might involve some borrowings from the market.

In short, the entire burden has been put on States at a time when they can scarcely afford it.

While many states accused the Centre of not giving them their due, the Centre, seeked legal advice from the Attorney General and has claimed that it has no obligation, due to the extenuating circumstances, to repay the shortfall in a time of sustained crisis.

These methods would mean that the Centre would not need to disburse any funds to the States. Either method, however, involves additional borrowings by the states, which would raise debt burdens at a time when resources are in extremely short supply.

Ultimately the 'Aam admi' (common man) will have to bear the burden when states cut back on developmental spending. The Centre may not be abiding by its social responsibility to bear the risks and burdens that individuals simply cannot.

Thanks!

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Akshay Seth
Research Analyst (SEBI Regd.)
Linkedin | akshay.equity@gmail.com

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