Over the past few weeks, there has been a heated discussion between the central and state governments about offsetting the goods and services tax (GST). The Center had assured states compensation for any shortfall in tax collection through 2022. Mint explores the issue.
Why is tax revenue so stressed?
Tax revenue is a function of economic activity. Higher activity growth means higher income, while lower growth means lower income. In the current circumstances, in which about 65% of economic sectors were closed during the pandemic, activity was limited. Consequently, tax revenue was negatively affected. The impact has been significant both in direct taxes such as income and corporate taxes, as well as indirect taxes such as customs and goods and services tax. However, as economic activity normalizes, tax collection is likely to improve and return to pre-pandemic levels.
What about the GST deficit of the states?
Several states were concerned about fiscal deficits due to the implementation of the GST. This problem was solved by the central government by ensuring that the states would be compensated in the event of any shortfall in tax revenue. Consequently, the compensation fee was collected and any compensation had to be paid out of the income generated through the compensation fee. However, the current circumstance is different, as the revenue shortfall is not due to the implementation of GST. Rather, it is due to a black swan event, which is the coronavirus outbreak.
See full image
Do the states have no guarantee of compensation in any case?
The states argue that the Center is legally and ethically obligated to provide them with GST compensation as promised. The Center recognizes the commitment made to make up the deficit as a result of the implementation of the GST. However, the pandemic has had a significant impact on tax collection, severely hampering the finances of the central government.
What about the proposals made by the Center?
The central government has proposed two solutions to the states. The first is to compensate only the fiscal deficit that arises due to the implementation of the GST and to allow states to borrow money, while the interest on the loans will be paid using the income from compensation. The other is to allow the states to directly borrow the entire fiscal deficit, but the interest in such a case will be paid by the state’s revenues, while the Center would guarantee a lower interest rate. States have rejected both proposals.
What does this mean for the citizens of India?
Policy prescriptions during recessions include a Keynesian stimulus in the form of high spending by governments. Therefore, providing states with spending money is critical to recovery, as state spending has a major impact on reactivation. However, with the states rejecting the proposals, the GST Council will have to find an alternative way to compensate the states. Meanwhile, states may have to resort to revenue collection by divesting from state PSUs and monetizing assets.
Karan Bhasin is a policy researcher.
.
