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Smart Arithmetic: Centre Agreeing to Take on GST Debt Should Help States' Finances

Sindhu Bhattacharya
·6-min read

The Centre has shown its arithmetic abilities in the game of one-upmanship with states over who foots the GST compensation shortfall in this pandemic year. After several opposition states threatened to take the entire matter to court, the Centre has now come up with a plan that makes it appear as if the Centre is retreating from its earlier combative position. But it isn’t.

It has now agreed to borrow Rs 1.1 lakh crore and on-lend to state governments to compensate them for the revenue loss arising out of GST implementation this year. Earlier, state governments were being asked to borrow this amount on their own, under a special window created for them.

The interesting part is this: despite the apparent climb-down, the Centre will manage to keep this increased borrowing out of the calculation of its own fiscal deficit and state governments will still be left with higher deficit figures. The only concession for the already stressed state governments’ finances in this option will be lower interest rates, since the Centre can avail of loans at interest rates which are lower than individual state governments.

And while the arithmetic of this borrowing programme is skewed in favour of the Centre, the decision could surely lower trust deficit with states. The entire fracas over GST compensation to states arose as Covid-19 and resultant lull in economic activities has meant a drastic fall in overall GST collections.

An official statement on Thursday said that: “Under the Special Window, the estimated shortfall of Rs 1.1 lakh crore (assuming all states join) will be borrowed by government of India in appropriate tranches. The amount so borrowed will be passed on to the states as a back-to-back loan in lieu of GST Compensation Cess releases. This will not have any impact on the fiscal deficit of the Government of India. The amounts will be reflected as the capital receipts of the state governments and as part of financing of their respective fiscal deficits.”

The Centre further said that this plan will help states avoid differential rates of interest and will also be an administratively easier arrangement. “It may also be clarified that the General Government (States+Centre) borrowings will not increase by this step. The states that get the benefit from the Special Window are likely to borrow a considerably lesser amount from the additional borrowing facility of 2% of GSDP (from 3% to 5%) under the Aatma Nirbhar Package.”

DK Srivastava, Chief Policy Advisor at EY, said that: “The only help to states with this plan will be that the amount will come to them at a somewhat lower interest rate.”

He said that the government could have avoided complicating the matter. “The most amicable way would have been not to offer two options but one straight option where entire GST shortfall was divided into two equal parts: one half to be borrowed by the Centre and on-lend and the second half by state governments themselves so that burden would have been equally divided.”

Sachin Menon, partner and national head (indirect tax) at KPMG, said that the government’s statement has been rather confusing. “It is not clear how the Centre’s position has changed from its earlier stand and the limit of Rs 1.1 lakh crore was already announced.”

After the Centre announced its climb-down, Kerala’s Finance Minister Thomas Isaac turned up the heat by demanding full compensation.

He also welcomed the government’s decision to borrow itself and on-lend instead of forcing state governments to borrow directly.

GST is a single indirect tax with multiple slabs for the entire country; it has subsumed central indirect taxes such as excise and customs tax and state-level levies such as value added tax, sales tax, octroi and luxury tax, etc. All goods and services are divided into tax slabs and five categories of goods – aerated drinks, pan masala, tobacco, automobiles and coal – attract an additional cess. The cess collected from the sale of these products is used to compensate states for revenue loss.

At the time of GST rollout in July 2017, the Centre had assured all states that it will fully compensate them for any losses arising due to the transition to GST for the next five years or till 2022. The compensation payable by the Centre is the projected revenue (at a compound growth rate of 14% from the base figure of 2015-16) of states for each year till 2022, minus the actual revenue.

But this year, the collection from the compensation cess has been estimated at just about Rs 70,000 crore, leaving a gaping hole of Rs 2.3 lakh crore. This is the sum over which the Centre and the states are engaged in a tug of war.

Earlier, the Centre had put two options on the table for state government.

First option: the Rs 1.1 lakh crore shortfall arising out of GST implementation be borrowed by states through issue of debt under a special window coordinated by the ministry of finance. This Rs 1.1 lakh crore is the estimated shortfall due to just implementation of GST and without the impact of the pandemic.

The Centre had said that interest on these borrowings will be paid from the cess (which will now be collected beyond 2022) and state governments will not be required to either service the debt or to repay it from any other source.

Second option: the entire shortfall of Rs 2.35 lakh crore (including the Covid-impacted portion) may be borrowed by states through issue of market debt. The Centre will repay the principal on such debt from future cess proceeds. But the state governments will have to bear the burden of interest on such loans.

The Centre’s decision to borrow itself and on-lend to states should boost the latter’s confidence in the federal framework in an otherwise tough year.