The friction between the Centre and states over GST compensation is the most important political economy challenge India faces. At least six state administrations, including BJP’s ally in Tamil Nadu, AIADMK, have written to the Centre asking it to reconsider its solution to compensate states this year for the expected shortfall in GST collections. The request is fair. The Centre should step up and make good the shortfall in larger national interest.
It all goes back to the grand bargain to usher in GST. To create a common market that would subsume 17 taxes and 13 cesses, states voluntarily surrendered unilateral powers of taxation over half their revenue base. To help them, a five-year compensation for revenue shortfall was legislated. Special cesses were levied to create a compensation fund. Compensation would kick in if a state’s GST revenue fell short of a threshold. The threshold was set at a compound growth of 14% over the tax collection in 2015-16. This year, the Centre estimates, the cumulative shortfall in GST will be Rs 2.35 lakh crore.
It was widely believed that if the compensation fund didn’t have enough money, the Centre would step in. The legal position, according to the Centre, has two elements. States are entitled to compensation regardless of what caused the shortfall, and the GST Council shall decide the solution if there’s not enough money in the compensation fund. Here, the Centre’s taking a narrow legal view to sidestep what was widely seen as its responsibility. The GST Council is not a body of equals. The Centre has veto power. Therefore, a solution is limited to what the Centre accepts. Moreover, the Centre has disproportionate power when it comes to borrowing.
The Centre has split the anticipated revenue shortfall between one arising out of implementation issues, amounting to about Rs 97,000 crore, and the residual amount presumed to be an act of god. It has offered states two options to borrow on their own account. This is not what Arun Jaitley, the finance minister who ushered in GST, had assured, say states. If they borrow the full Rs 2.35 lakh crore to offset the shortfall, not only will they have to pay interest but likely reduce infrastructure spending as their borrowing limit runs out. Therefore, the most efficient and just solution is for the Centre to borrow and compensate states. It can extend the compensation cess to cover its cost. This will limit the economic damage.
This piece appeared as an editorial opinion in the print edition of The Times of India.