States' fiscal health falling apart over shortfalls in GST compensation

Finance ministers of five states jointly complained about the delay in release of goods and services tax (GST) compensation, and held the Centre accountable for this earlier this week. The delayed amount — for all states put together — is more than Rs 20,000 crore.

States are indeed facing shortage in cash flow to run the administration and finance their schemes, as well as capital spending.

Going by official government accounts, while the Centre seems to be fairly comfortable in its GST revenue position, states are in a precarious position, as they have garnered only 38 per cent of annual GST target in six months.

This has been exacerbated by slow growth in sales tax and state excise collections.

If slowdown in the economy persists longer — two of these three taxes are consumption based — the fiscal crisis of the states is set to deepen. As states take responsibility of two-thirds of overall national capex, this would damage productive public spending, adversely affecting job creation.

All this is happening at time when states’ share in income taxes has already been trimmed because of corporation tax rate cuts and rise in share of indivisible tax revenue (in the form of cess and surcharge).

This year, in the first six months, while the Centre collected compensation cess amounting to just above Rs 46,000 crore, the compensation actually released to states has run into Rs 66,000 crore. On the collection side, while fall in auto sales reduced the collection, overall crunch in states’ GST revenue rose the need for compensation to be released. 

Under the law, if states’ GST revenue does not grow by at least 14 per cent, the Centre pays them the difference, after every two months.

One estimate of availability of funds puts the the amount accrued in October and the unspent balance from the previous year at above Rs 30,000 crore. Senior officials said the Budget exercise which involves calculation of revised estimates, has caused the delay.

Punjab’s example is important in this case.

According to Punjab Finance Minister Manpreet Singh Badal, the Centre owed the state Rs 4,100 crore, including Rs 2,100 crore of compensation for August and September, plus past arrears.

“States have to run health services, prisons, education, police and social security. These things cannot wait. If the compensation doesn’t come, we will be in overdraft," he said. “There needs to be a dispute-resolution mechanism to ensure that we are able to get what rightfully belongs to us,” Badal added.

Madhya Pradesh has fared the poorest in GST collection in FY20, raking in 30 per cent of the annual target. Kerala, Punjab, and Tamil Nadu have collected about 33 per cent, data on the CAG website shows.  

States’ fiscal worries do not stop here.

The compensation on GST shortfall would end in 2022. According to reports, there is likelihood that the 15th Finance Commission would reduce their share in the divisible pool of tax revenue collected by Centre.

But at present, their problems have been exacerbated by the consumption slowdown. Though they have got more amount as compensation than that collected by the Centre, other sources of revenue are not at par.

“The slowdown has affected the consumption of items from liquor to automobiles. This has resulted in tepid growth in excise, value added tax collections, too,” said a sales tax commissioner from a big producing state. Producing states such as Gujarat and Karnataka are already seeing slower growth in GST revenues, in comparison to net consuming states such as Bihar.

This is prompting states to borrow more short term debt in form of treasury bills, which is not sustainable, said state finance ministers. An ICRA report shows that gross borrowing by states has grown 38 per cent this fiscal to date, and is set to touch a massive Rs 6 trillion.

"We cannot borrow endlessly. We have to comply with the limits provided by the fiscal responsibility and budget management Act when it comes to borrowing," Amit Mitra, finance minister of West Bengal, said. His state, has surprisingly collected 46 per cent of its annual target in six months.  

Taking all these factors into consideration, states are voicing their demand to extend the compensation period by another three years, propelled by their under-confidence about economic revival and buoyancy in revenue collection. This will lock their annual revenue growth at a minimum of 14 per cent irrespective of actual collections till 2024-25.

The Reserve Bank of India highlighted the pressure on capex by states, showing that productive expenditure in food processing and the power sector have taken the hit.