Bumper GST collections could lead to compensation windfall for states

Last week, Finance Minister of Kerala K N Balagopal wrote to Union Finance Minister Nirmala Sitharaman regarding the finances of the state. Balagopal blamed the centre for putting it in a grave financial crisis by slashing its resources by Rs 23,000 crore in the current fiscal year.

He said that the centre had done so by reducing revenue deficit grants, ending goods and services tax (GST) compensation from July, and factoring in borrowings by state entities as public account liability while fixing borrowing limits of Kerala and other states.

Kerala was the latest among states that have formally or informally had a word with policymakers in the finance ministry about their finances after two years of the Covid-19 pandemic, with the extension of GST compensation at the centre of these conversations.

Extending compensation is a topic that has remained a sticking point in India’s federal structure, with not only opposition states but also BJP-governed states speaking about it. After the last GST Council meeting in Chandigarh, Sitharaman had said that 16 states had spoken on the compensation issue, cutting across party lines. No decision was taken.

However, central government officials and most independent experts say that the improved GST receipts mean that the compensation is unlikely to be extended, as most states will see windfall collections this year.

Also Read: GST collection jumps 28% YoY in July to second highest ever at Rs 1.49 trn

Additionally, central officials say that the unpaid compensation arrears to states, which the government plans to clear soon, will also help.

“We have front-loaded the GST compensation arrears and will soon pay the remainder also. This year actually states won’t have any cash flow problem once the arrears are cleared. We have already cleared arrears of Rs 85,000 crore and including for June, the arrears cleared for this year will be above Rs 1 trillion,” a top government official told Business Standard.

The official said that with GST collections showing a healthy trend, there is no case for the extension of compensation. For FY23, collection from GST compensation is estimated to be at Rs 1.2 trillion for only till June. Last year (FY22) it was Rs 1.05 trillion.

GST collection remained above Rs 1.4 trillion for the fifth month in a row, increasing 28 per cent year-on-year to nearly Rs 1.49 trillion in July. This was the second-highest mop-up since the rollout of the regime. The uptick is mainly on account of improved economic activities, compliance measures and inflation. The highest-ever mop-up was recorded in April this year (Rs 1.68 trillion).

“GST revenue has grown 35 per cent YoY till July, displaying very high buoyancy,” the finance ministry said on August 1. Indeed, nearly four states have said that they are evolving their own revenue stream to break from the compensation mechanism.

“Right now, the year-on-year growth in GST collections is very high. Depending on what normative growth would be assumed for calculating GST compensation, all states may not even need it,” said Aditi Nayar, Chief Economist with Icra Ltd.

“If GST compensation were to be extended, the question remains how it would be funded, as the cess collections for the next few years are earmarked for paying the arrears and interest and principal of the borrowed shortfall amounts,” Nayar said.

The centre’s official stand is that GST compensation was paid to states only till June, as mandated by the GST (Compensation to States) Act. Though cess will be collected till 2026, it will be used to pay back the principal and interest of the compensation shortfall loans worth Rs 2.69 trillion that the centre borrowed in 2020-21 and 2021-22, and transferred to states. The shortfall in compensation happened due to the hit to the Indian economy arising out of the Covid-19 pandemic.

So, this means that in an improving economy, states will have to tighten their own revenue streams. As experts and government insiders point out, this means greater scrutiny, intelligence gathering and more investigations.

“Considering the large amount of data available with the Central and State GST authorities and the need to constantly improve the collections, it is expected that the GST audits and enquiries will increase significantly,” said M  S Mani, Partner, Deloitte India.

Some experts, however, say that after two years of pandemic-induced hit to the finances of the states, some form of extension of compensation should be considered.

“Since state governments are a major part of the economic recovery process, there is a case for extending the compensation,” said N R Bhanumurthy, vice-chancellor of Dr B R Ambedkar School of Economics, Bengaluru.

Bhanumurthy explained that since GST has been implemented, for various reasons, the growth rate has declined, which has led to miscalculation of expected revenue by the states.

“On the other hand, there are committed expenditures. Covid has led to increase in state finances. If you look at last one year, GST proceeds are much higher than what anyone expected,” he said.

The buzz in bureaucratic circles is that there could be an option of extending compensation by a couple of years, and at a lower assumed rate than the 14 per cent taken for the first five years. This will of course require amendments to the GST compensation law. But these could just be rumours.