Model Answer
0 min readIntroduction
The Goods and Services Tax (GST), implemented in July 2017, was a landmark indirect tax reform in India, aiming to create a unified national market. However, states expressed apprehension about potential revenue losses due to the shift from a destination-based tax system and the subsuming of various state taxes. To address these concerns, the GST (Compensation to States) Act of 2017 was enacted, providing a guaranteed compensation to states for any revenue shortfall arising from the implementation of GST for a period of five years. The COVID-19 pandemic significantly disrupted economic activity, severely impacting GST collections and creating a crisis in the compensation fund, leading to heightened federal tensions between the Centre and states.
Rationale Behind the GST (Compensation to States) Act, 2017
The GST (Compensation to States) Act, 2017, was rooted in the political consensus reached during the GST Council meetings. The core rationale was to ensure a smooth transition to the GST regime and to protect the revenue interests of states. Key aspects of the rationale include:
- Addressing Revenue Concerns: States feared a loss of fiscal autonomy due to the shift to GST. The Act guaranteed a 14% annual growth in GST revenue over the base year of 2015-16 for the first five years (2017-2022).
- Compensation Mechanism: If a state’s revenue growth fell below 14%, the difference was to be compensated by the Centre through a dedicated GST Compensation Cess.
- Cess Collection: The GST Compensation Cess was levied on luxury and demerit goods like automobiles, tobacco, and aerated drinks.
- Building Trust: The Act aimed to build trust between the Centre and states, fostering cooperation in the implementation of GST.
Impact of COVID-19 on the GST Compensation Fund
The COVID-19 pandemic and the subsequent lockdowns had a devastating impact on the Indian economy, leading to a sharp decline in GST collections. This created a significant shortfall in the GST Compensation Cess collections, making it difficult for the Centre to fulfill its commitment to compensate states.
- Revenue Contraction: GST collections plummeted during the lockdown periods of 2020-21. For instance, GST revenue in April 2020 fell by over 60% compared to April 2019. (Source: PIB releases, knowledge cutoff 2023)
- Cess Shortfall: The decline in consumption of luxury and demerit goods, on which the GST Compensation Cess was levied, further exacerbated the shortfall.
- Increased Demand for Compensation: States experienced a significant revenue shortfall, leading to increased demands for compensation from the Centre.
- Borrowing to Bridge the Gap: To meet the compensation demands, the Centre had to borrow funds and release them to states in tranches. Initially, the Centre resisted borrowing, but eventually agreed to facilitate borrowing by states themselves.
New Federal Tensions
The COVID-19 induced crisis in the GST compensation fund led to significant federal tensions between the Centre and states. These tensions manifested in several ways:
- Disagreement on Borrowing Mechanism: States opposed the Centre’s proposal to borrow funds to meet the compensation shortfall, arguing that the responsibility for compensation lay solely with the Centre.
- AGM Disputes: Disagreements arose regarding the methodology for calculating the GST revenue shortfall and the amount of compensation due to each state.
- Extension of Compensation: Several states demanded an extension of the GST compensation period beyond 2022, which the Centre rejected.
- Trust Deficit: The crisis eroded trust between the Centre and states, raising concerns about the future of cooperative federalism in India.
The issue highlighted the inherent challenges in fiscal federalism, particularly in times of economic crisis. The Centre’s unilateral decisions regarding borrowing and compensation were perceived by some states as a violation of the spirit of GST Council consensus.
| Aspect | Pre-COVID-19 | Post-COVID-19 |
|---|---|---|
| GST Revenue Growth | Generally above 14% | Significantly below 14%, negative growth in many months |
| Compensation Cess Collection | Sufficient to meet compensation demands | Insufficient, requiring borrowing |
| Centre-State Relations | Generally cooperative | Strained, marked by disagreements and mistrust |
Conclusion
The GST compensation mechanism, while initially successful in facilitating the implementation of GST, faced an unprecedented challenge due to the COVID-19 pandemic. The crisis exposed vulnerabilities in the fiscal federal structure and led to heightened tensions between the Centre and states. Moving forward, a more sustainable and equitable revenue-sharing mechanism is needed, along with greater transparency and consensus-building within the GST Council. Strengthening cooperative federalism is crucial for the long-term success of GST and the overall economic development of India.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.