The Union government will honor its commitment to compensate states for the deficit in the collection of taxes on goods and services (GST) despite the strain on their finances due to the pandemic, said a senior government official.
A portion of the compensation promised to the states, ₹Rs 97 billion would be paid immediately and the balance over a period to be decided by the GST Council, the main body that will guide the implementation of the indirect tax.
The clarification from the Union government comes just days before the GST Council meeting on September 19. If the states accept the new proposal, it could potentially avoid the nasty showdown that was seen at the last meeting between the Center and the states. Differences at the previous Council meeting had begun to threaten the GST pact, which had been presented as the new model of cooperative federalism.
The senior government official said the Center is committed to fully compensating the states. “One hundred percent (will be paid),” the person said. The person who did not want to be identified referred to May 20 mint interview with the Minister of Finance, Nirmala Sitharaman, in which she has made it explicit.
The initial compensation will be paid immediately through loans, as this payment must be made during the five-year transition period of the indirect tax reform. The deficit due to covid-19 will be paid as the tax is extended. Paying this after the fifth year by extending the tax will help states avoid a fiscal gulf after normal compensation ends in 2022.
“As long as that law exists, the GST (Compensation to States) Law of 2017, I have to comply with it,” the Minister of Finance had said in the interview.
The official said the Center called a meeting of the state finance secretaries last week to clarify its position. In the nearly three-hour meeting, the Union government developed the options shared with the states at the last meeting.
The bone of contention is the Center’s commitment to compensate the states for any shortfall in revenue that may arise during the implementation of the GST. Dubbed the “big deal,” the states gave up their right to tax to make way for the new indirect tax regime. In return, states were guaranteed 14% annual revenue growth through fiscal year 22.
However, the pandemic has triggered an unprecedented economic disruption, leading to a decline in tax revenue. The total compensation owed by the Center is ₹2.35 trillion.
At the last meeting of the GST Council, states were offered two loan options to cover revenue losses due to the implementation of GST or the entire deficit, including the effect of the pandemic. The options involved states that borrow under a special RBI or market window on different terms.
The Center would prefer that states borrow to fund repayment, as by law, tax collections accrue to states and only states can borrow against their collateral. Furthermore, on average, states have so far borrowed just 1.2% of state gross domestic product versus the 5% allowed. “If the center borrows, it will increase returns and affect the cost of borrowing for everyone. It is not the right thing to do when we seek to reactivate the economy and encourage companies to invest, “the official said.
To make things easier for states, the Center has started a conversation with the Reserve Bank of India to open a special window in which all states would access loans at the same rate.
In addition, these loans will be linked to collections in process, so repayments will be settled through payment receipts and will not put pressure on state budgets.
Things got ugly at the previous GST Council meeting after states split along political lines and those ruled by the opposition upped the ante. States not governed by the BJP insisted that the Center should borrow and pay compensation, which could be repaid from the proceeds.
It remains to be seen if the olive branch offered by the Center will appease the states and bring them back to the negotiating table.
The experts welcomed the flexibility of the Center to resolve the backlog related to the issue of compensation. This sets the stage for more fruitful talks on the GST compensation cut-off changes, they said. “This is a welcome step,” said NR Bhanumurthy, Vice Chancellor of the Dr BR Ambedkar School of Economics in Bengaluru.
MS Mani, Deloitte India’s tax partner, said it was essential to have a constructive discussion on the period during which the cessation may need to be extended and whether it was necessary to review the products that are subject to cessation.
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