Fulfill the promises made to states while implementing GST, Center responsible for managing Indian economy

Jaipur | Rajasthan Chief Minister Ashok Gehlot has urged the Central Government to fulfill the promises made to the State Governments while implementing GST and leave it to the State Governments to have the right to certain taxes being implemented by the Center. He has demanded Prime Minister Narendra Modi to intervene in this matter to maintain confidence in the financial relations between the Central Government and the states.

See Complete Letter by Ashok Gehlot

I write this letter to convey the concerns of the Government of Rajasthan with regard to the hurdles in the payment of Goods and Services (GST) compensation to the states.

I wish to draw your attention to the suggestion made by the Government of India in the 41st meeting of GST Council held on 27.08.2020, through video conferencing, that the states should resort to borrowing to cover the shortfall in the GST compensation cess. While accepting that compensation is payable for the entire shortfall, the Central Government's position is that this is to be paid only from the Compensation Fund and is not Government of India's obligation to finance the shortfall. This is against the letter and spirit of the constitutional amendment by which the states gave up their constitutional right to levy certain taxes in favour of the central government as well as the understanding reached in the 7th, 8th and the 10th meetings of the GST Council meetings.

The Constitutional Amendment allowing for the merger of several States' taxes into GST,  states that compensation shall be provided to the States "...for loss of revenue on account of implementation of the goods and services tax..." Under The GST (Compensation to States) Act, 2017, States are guaranteed compensation for loss of revenue on account of implementation of GST for a transition period of five years, starting from 2017. The Compensation Act defines the words "loss arising on account of implementation of the GST" stated in the Constitution. This is unambiguously stated in the Preamble to the Act which reads as follows: "An Act to provide for compensation to the States for the loss of revenue arising on account of the implementation of the goods and services tax in pursuance of the provisions of the Constitutional (Hundred and First Amendment Act), 2016)". The word "compensation" has been further defined in Section 2(d) of the said Act in the following manner: "Compensation means as amount in the form of goods and services tax compensation, as determined under section 7". In Section 7 of the Act, the manner of calculating compensation (difference between the projected revenue and actual revenue) is provided for.

It is clear from above that it is the obligation of the Central Government to ensure that the States receive, without liability, the full amount of compensation, notwithstanding the shortfall in the collection of cess and that the compensation can neither be increased nor decreased without amending this Act. I would like to emphasize that the quantum of compensation to be paid to the states is not an executive decision of the Central Government or the Council but is a legal obligation on the Government of India under the Act. Whereas, the former Finance Minister late Shri ArunJaitley had stated that the GST Council could consider raising additional resources including through borrowing, it was never the understanding that the states would borrow this additional amount. The Council does not have the power to alter the compensation mechanism without getting the Act amended. Therefore, there is no ambiguity that the shortfall in revenues must be met by revenue transfers from the Central Government.

I would also like to draw your attention to the minutes of the 7th, 8th and the 10th meetings of the GST Council in which the following decisions were reached

The compensation would be 100% of the revenue loss.

It would be paid within the stated five year period (2017-22).

It is the obligation of the Central Government to pay the full amount.

Only the matter of funding would be decided by the GST Council.

If there is a shortage, the Central Government could resort to borrowing.

In the GST Compensation Bill it was not specifically mentioned that liability of the payment was on the Central Government. On being pointed out in the 10th meeting, the Secretary of the Council stated (as recorded at para 6.5 on page 13) that "Central Government could raise resources by other means for compensation and this could then be recouped by continuation of cess beyond five years. He stated that other decision including possibility of market borrowing for payment of compensation was part of the minutes of the 8th meeting and need not be incorporated in the law. The Council agreed to this suggestion." It is evident that even though the GST Compensation Act does not state specifically that the centre would pay, this was discussed at the Bill stage and the Council agreed with the wordings of the draft Bill in view of the assurance given by the Secretary. There was no cause for the State Governments to doubt the intention of the Central Government at that stage. It must be noted that the GST is based on the collective decision making between the states and the Central Government within the four walls of the Constitutional Amendment and the Compensation Act.

I would also like to draw your attention to some of the other critical issues linked to the payment of compensation. If the states borrow from the RBI, will the RBI hold state government debt on its balance sheet as it does that of the Central Government? Secondly, would the loans so taken be interest bearing?   It is inequitable because under the RBI Act, all RBI surpluses are transferred to the Government of India as dividend. While the Central Government reneges on its promise of paying the compensation to the states, it would end up making profit from the interest paid by the states.

I am also of the firm belief that any intention that in the final year of compensation the states should accept a 0% increase as against the mandated 14% is unfair and without any justification. 

The management of the Indian economy is the responsibility of the Central Government and as it benefits from the upside, it is also expected to accept full responsibility for the shortfall in GST collections due to the downside of the economic cycle. Government of India is only recognizing GST loss by assuming a 10% growth over the previous year and attributing the rest to the COVID pandemic. This is arbitrary, takes only the interest of the Central Government into account and has no legal justification. It must be noted that GST revenues were growing at about 4% in 2019-20, which was the pre-COVID year, GDP growth in the last financial year was 4.2%. Therefore, applying a rate of 10% growth to project a higher revenue loss due to COVID is statistically untenable and factually unsound. 

There is no case for the State Governments to borrow to meet the shortfall in the Compensation Fund. The Government of India should bear the responsibility of borrowing from the RBI and disbursing to the States as compensation. It can continue to collect cess to repay the RBI beyond the five year period determined for raising of the cess for now.

I request your intervention in the matter for fulfilling the promise made by the Government of India while persuading the State Governments to accede to the introduction of GST and to give up their right to levy certain categories of taxes. Your intervention is also requested to restore underlying good faith and trust in the fiscal relations between the Central Government and the States.