Extension of GST Compensation as a Reform Catalyst

It has been claimed that the implementation of the Goods and Services Tax (GST) in India was a grand experiment in cooperative federalism in which both the Center and the states joined hands to rationalize domestic trade taxes and develop a value-added tax on goods. and services. Although the rate structure was considered revenue neutral, the states agreed to relinquish their revenue autonomy in favor of tax reconciliation. This was in the hope that it would become a money machine in the medium term due to better compliance arising out of the self-policing nature of the tax.

calculation

To allay apprehensions of possible revenue loss to the states from the implementation of GST in the short term, the central government promised to pay compensation for any loss of revenue in the five-year development phase. The compensation was to be calculated as the shortfall in the actual revenue collection in GST that the states would have received from the taxes merged with the GST. It was estimated in 2015-16 by taking the revenue from merged taxes as the basis and applying a growth rate of 14% every year. To meet the compensation requirements, GST Compensation Cess was levied on certain items like tobacco products, automobiles, solid fuels manufactured from coal and lignite, pan masala and aerated water.

Unfortunately, the compensation saga was not without controversy. In the first two years of its implementation, the amount of compensation to be paid to the states was modest and sufficient to meet the compensation cess requirements. In fact, the cess collection exceeded the compensation requirements by ₹21,466 crore in 2017-18 and ₹25,806 crore in 2018-19.

cause of distrust

In 2018-19, the shortfall in payment requirement from cess collection was ₹24,947 crore which could have been met from the last two years’ surplus kept as balance in the Compensation Fund. However, in 2020-21, due to the most severe lockdown since the novel coronavirus pandemic, the loss of revenue to the states was estimated at ₹3 lakh crore of which ₹65,000 crore was expected to accrue from the compensation cess. Out of the remaining ₹ 2.35 lakh crore, the central government decided to pay ₹ 1.1 lakh crore by borrowing from the Reserve Bank of India under a special window and interest and repayments were to be paid from collections from the compensation cess in future. , However, the entire compensation payment episode plunged Centre-State relations to a new low, creating huge distrust.

The agreement to pay compensation for loss of revenue was for a period of five years which would expire by June 2022; And given the uncertainty in revenue collection before the states, they want the compensation scheme to continue for the next five years.

core issues

Although it was hoped that the tax structure would stabilize in the first five years, reform is still in transition.

Firstly, the technology platform could not be strengthened for long, due to which the initially planned returns could not be filed. This led to misuse of input tax credit by using fake invoices on a large scale. The adverse impact on revenue collection due to this was compounded by the pandemic-induced lockdown.

Second, it is the only major source of revenue for the states and given their increased spending commitments to protect the lives and livelihoods of the people, they would like to reduce the revenue uncertainty to the extent that they can. They have no means to mitigate this uncertainty for the Finance Commission, which should take into account the capabilities and needs of the states in its recommendations, has already submitted its recommendations; The next recommendations of the commission will be available only in 2026-27. More importantly, there is a need for significant changes in the composition of the GST and the cooperation of the states to carry out the necessary reforms.

a case for revision

It is very well accepted that the structure of GST requires significant reforms. Notably, about 50% of the consumption goods included in the Consumer Price Index are on the exempt list; There is a need for significant pruning of these items to widen the tax base.

Second, sooner or later it is necessary to bring petroleum products, Real estate, liquor for human consumption and electricity under the purview of GST.

Third, the current structure is very complex with four main rates (5%, 12%, 18% and 28%). This is in addition to a cess on precious and semi-precious stones and metals at special rates and rates ranging from 15% to 96% of the tax rate applicable on ‘aguna’ and luxury items, which has greatly complicated the tax. Multiple rates complicate the tax system, cause administrative and compliance problems, create an inverted fee structure and give rise to classification disputes. Reforms in the structure are essential for integrating rates and this cannot be done without the cooperation of the states. They will not agree to rationalize rates unless and until compensation for revenue loss continues to be paid.

Thus, extension of compensation payment for loss of revenue for the next five years is necessary not only because the transition to GST is still underway, but also to provide relaxations to states to participate in the reforms. . GST is the most important source of revenue for the states and any revenue uncertainty from that source will have a serious adverse impact on public service delivery.

Similarly, reforming the structure to complete the process of transition to an appropriately well-structured GST is important not only to enhance the tax buoyancy in the medium term but also to improve ease of doing business and reduce distortions. It is also important for reducing administrative and compliance costs. , It has been pointed out by many, including the Fifteenth Finance Commission, that the compensation scheme to implement the 14% increase on the base year revenue provided for the first five years was too liberal. The issue may be revisited and the growth rate of reference revenue for computing compensation may be linked to the growth of GSDP in states to ensure minimum certainty on revenue. This will encourage them to complete the reform in the true spirit of cooperative federalism.

M Govinda Rao is a former Director, National Institute of Public Finance and Policy and a member of the Fourteenth Finance Commission. He is currently the Chief Economic Advisor at Brickwork Ratings. views expressed are personal