Sorry state: GST cess may stay for two years beyond FY22 : 03-08-2020

The Centre and states will likely resolve the vexed issue of a yawning deficit in the GST compensation cess fund by resorting to market borrowings this year, and finance it by retaining the cess for a year or more beyond the current end date of FY22. The borrowing requirement could be around `2 lakh crore, according to an FE estimate. If a state agrees to settle for a lesser compensation, given the unforeseen circumstance created by Covid-19, then the borrowing size would reduce.

But what could become a bone of contention as the GST Council discusses the issue at its next session is who will borrow – the Centre or the states or the GST Council.

Armed with the attorney general’s (AG) opinion that it is under no legal obligation to make up from its own coffers any shortfall in GST revenues of states from the ‘protected’ level, the Centre will want the states to raise the debt and service it out of the bolstered cess proceeds. But the states are unlikely to buy into the argument, as they fear that the debt will likely impose a cost on them. The compensation funds, after all, were supposed to be part of their income, sans any cost. Even the likely promise of a fiscal forbearance may not quite convince them.

Entrusting the GST Council with the borrowing obligation will require corporatisation of the entity. To cut the borrowing cost, loans to be raised by the Council will have to be under sovereign guarantee, meaning as contingent liabilities these could possibly raise the public debt. Also, a mechanism will need to be evolved on sharing of the borrowing costs between the Centre and states. The legal tenability of this option is open to contentions.

It is possible that the discord will finally be resolved in the courts.

Since the overall borrowing limit by the Centre and states for FY21 has already been raised by 40% to a massive `22.69 lakh crore, and the Centre is still talking about giving another dose of fiscal stimulus to the economy by mid-year, the proposed additional government borrowings for the explicit purpose of states’ GST compensation would be much costlier to the exchequer – perhaps the costliest in history.

Of course, given the (reformist) conditions attached to utilisation of the extra borrowing space and for their own reasons of prudence, many states may not fully use it. But that is barely a solace, as overall government borrowings will still be high enough to overcrowd the market, despite the robust systemic liquidity. Also, banks will be wary about subscribing to bonds issued by states, given that many of them are fiscally very weak.

Though there are supplementary options to bolster the compensation fund, including levying the cess, now applicable to specified ‘sin and luxury goods’ on more items and making it ad valorem in all cases, these are not immediately viable due to the deep economic slump. Some states, however, may also seek to innovatively use the non-GST revenue space opportunistically, over the course of this year to strengthen their own tax receipts.

As part of the grand bargain struck between the Centre and states prior to the GST’s implementation, the GST (Compensation to states) Act, 2017, provided for a protected revenue growth of 14% over the base year of 2015-16 during the transition period (first five years of GST) to states. It is now clear that the Centre, guided by its dogged determination to roll out the epochal tax reform, was too generous in giving states this assurance. It could have made the relief receptive to GDP growth, at least.

The overall GST revenue growth was just 3.8% in FY20; most likely, the growth would be negative in the current fiscal. Though one reason for the GST revenue growth being below expectations is the slower-than-expected economic growth rates since its introduction, it may be noted that the tax was much less comprehensive than envisaged, for it to bring about the desired-for revenue productivity. Also, the GST was launched with its weighted average rate being significantly below the revenue neutral rate estimated; a series of rate cuts by the GST Council and the below-optimal efforts at plugging revenue leakage/evasion indeed widened the gap.

The GST collection, including the cess revenue, was about Rs 2.73 lakh crore or about Rs 68,100 crore/month in the first four months of the current fiscal. The collection was Rs 87,422 crore in July. Assuming that average monthly collection in the remaining eight months of the year is about Rs 90,000 crore, the mop-up in the year, will be close to Rs 10 lakh crore. This could include cess fund of Rs 85,000 crore (some Rs 10,000 crore less than the Rs 95,444 crore collected in 2019-20). Minus the cess fund, the GST revenue for the current year could be Rs 9.15 lakh crore, and @50%, states will eventually lay their hands on nearly Rs 4.6 lakh crore.

Against the protected revenue of Rs 7.64 lakh crore to states for the year, this implies a shortfall of Rs 3 lakh crore, and net of cess fund of Rs 85,000 crore, the shortfall is Rs 2.1 lakh crore or thereabouts. Of course, if the average monthly GST collection in the August-March period turns out to be Rs 95,000 crore, the compensation requirement will reduce by about Rs 20,000 crore, so the borrowing required to bridge the shortfall will be around Rs 1.9 lakh crore.

The Centre had released over Rs 1.65 lakh crore in 2019-20 as GST compensation; it used surplus from the cess pool of previous years and undistributed I-GST collection of Rs 33,412 crore for FY18 to compensate the states last year.

On their part, the state finance ministers are asking for a solution to the issue, that doesn’t allow the Centre to renege on the promise of assured compensation to states during the transition period. Of course, if the economy picks up next fiscal, a rate overhaul and widening of the GST ambit might be part solution to the issue of low revenue growth in 2011-22 and beyond. For the current year, however, borrowings to be financed by the additional cess proceeds to be generated out of the extension of the impost seems the only way out.

Kerala finance minister Thomas Isaac tweeted: “AG opinion seems to be that if there is no money in Cess Fund it’s is up to GST Council to make appropriate arrangements. Fine. But Centre has 1/3rd votes in Council. No decision can be taken without its concurrence. So the question is , what is it’s stance? To pay or not to pay?”

In a recent letter to finance minister Nirmala Sitharaman, Punjab finance minister Manpreet Singh Badal suggested a few steps to bolster the cess proceeds, including a shift from specific cess rates to ad valorem in all cases, subsuming of the central excise duty imposed in recent Budget on cigarette and a certain tobacco products in the cess, full restoration of the diverted IGST funds of 2017-18 and imposition of cess on services “meant predominantly for the rich”.

“Any shortfall after these adjustments may be met through central borrowings. This will be both efficient in terms of cost of borrowings as well as equity,” he wrote. “The states should not be made to bear the burden of borrowing, which in any case is likely to be higher than the rate at which the Centre will be able to borrow”, Badal iterated.

West Bengal finance minister Amit Mitra has maintained that it is for the central government to devise a mechanism for payment of compensation to states, if the fund set up for the purpose runs dry, as the relevant law is silent on an alternative mechanism.

Section 8 of the Compensation Act provides for imposition of cess to generate proceeds for compensation, the cess is being levied on a clutch of items, including pan masala. tobacco, coal, briquettes, ovoids, aerated waters and motor cars. Although the Act says the compensation shall be payable to any state during the transition period and “shall be provisionally calculated and released at the end of every two months period, and shall be finally calculated for every financial year after the receipt of final revenue figures, as audited by the Comptroller and Auditor-General of India”, there have been delays in the release of funds of late.

Source : Economic Times