The Union government is committed to compensate states for their entire Rs 2.35 lakh crore Goods and Services Tax (GST) shortfall in 2020-21 irrespective of the reason for the fall in revenue, which is either due to GST implementation issues or because of coronavirus disease (Covid-19) pandemic, an act of God, two finance ministry officials said.
It has never been the stand of Union finance minister Nirmala Sitharamaram that the loss of revenue due to Covid-19 would not be compensated, the officials said requesting anonymity.
“The entire compensation sum on account of shortfall in collections of GST will be paid and honoured. The news and opinion circulating in the media that the Centre is not honouring its committment is false and baseless and is aimed at creating unnecessary confusion,” one of the officials said.
The officials said the revenue shortfall would, however, be met through market borrowing by states themselves as per the legal position.
“Compensation cess is a resource dedicated to states. Only states can borrow on the strength of future flows from cess that will eventually get credited to their consolidated fund,” one of the officials said.
However, the states that are ruled by parties in the opposition rejected the Centre’s position about market borrowings.
“The states want the Centre to fulfil its constitutional obligation. It should pay full compensation of Rs 2.35 lakh crore in the current financial year. It should borrow the full amount from the market for us. The debt will certainly be retired from the compensation fund,” said a finance minister belonging to a state ruled by opposition parties, requesting anonymity.
These states have rejected the two options of revenue compensation proposed by the Centre last week, he said.
On August 31, Kerala finance minister Thomas Isaac had tweeted, “FMs [finance ministers] of Punjab, Delhi, West Bengal, Chhattisgarh, Telangana and Kerala agreed to reject the Centre’s options on GST compensation. Our option: the central government to borrow entire compensation due regardless of acts of gods, humans or nature, to be paid back by extending the period of cess.”
The Centre on August 27 had decided to go for the borrowing route to compensate states for the GST revenue shortfall. It gave options one for Rs 97,000 crore and the other for Rs 2.35 lakh crore. Two days later, it circulated the details of the two options to the states.
Under the first option, states would not have to pay either principle or interest if they opt to borrow Rs 97,000 crore to meet GST revenue shortfall because of implementation issues, but they will have to bear significant interest costs if they choose the lager borrowing option of Rs 2.35 lakh crore due to an “Act of God”, the Covid-19 pandemic.
“If states go for the first option and borrow Rs 97,000 crore, it does not mean they will have to forego the remaining compensation. The remaining compensation will be paid to states after the borrowing has been fully repaid. Where is the doubt about the Centre not meeting its committment?” said the official quoted above.
He explained the Centre’s constraints regarding borrowing to pay the GST compensation. “It needs to be appreciated that under the GST law, the compensation cess is a tax owned by states and under Article 292 of the Constitution, the Centre can borrow on the security of its own taxes and resources which is the Consolidated Fund of India. It cannot borrow in the security of the tax that it does not own,” he said.
“The compensation cess has to be transferred to the Compensation Fund of India and released to states in the form of compensation. It is not a resource of the Central government on the strength of which it can borrow under Article 292 of the Constitution,” he added.
Compensation cess is a resource dedicated to states. Only states can borrow on the strength of future flows from cess that would eventually get credited to them, he said.
Officials said that partially meeting the resource gap through borrowing is beneficial for both the market and states. “It will ensure that some resources in the form of compensation keep coming even after the end of the transition period which will allow future generations to maintain healthy levels of public expenditure. States falling off a resource cliff after the transition period of five years will not be a prudent fiscal strategy,” the official quoted above said.
The GST law assures states a 14% increase in their annual revenue for five years from July 1, 2017 and also guarantee them that their revenue shortfall, if any, will be made good through the compensation cess levied on luxury goods and sin products such as liqour, cigarettes, aerated water, automobiles, coal and tobacco products.
The finance ministry officials said states have fiscal space to borrow. The Centre has already enhanced the borrowing limit from 3%, which goes up to 5% of gross state domestic product (GSDP). On average, the states have borrowed around 1.25% of the GSDP. Only a few states have reached around above 2% of the GSDP. Enough headroom is available to states to borrow as per their requirements and needs, they said.
“In any case, they will get the full compensation shortfall and it is a win-win situation for all states, the Centre, and economy” a second official said.
He said if the Centre borrows it would have a higher impact on the market and push the G-Sec rate which becomes the benchmark rates for other borrowings including that by state governments. “Any borrowing by the Central government would crowd out borrowings by the private sector and will make them costly for entrepreneurs. The deciding factor will be whose borrowings will have least impact on market rates” he added.
“It is inarguable that rates on Central government securities work as one of the benchmarks for market rates. Any additional borrowings by the Centre will have a higher impact on the market rates than that by states. If the benchmark rates increase on account of borrowing by the Centre, states, too, will get impacted because it will increase their cost of borrowing,” he said.
“In the current scenario, it may be a safer option for states to raise the additional resources to meet the resource gap due to non-availability of compensation. Since the repayment will come from the compensation cess, there is no reason why the rates will be different for each state. The debt window could be packaged in a way that it is state independent altogether,” he added.