The GST is at a crossroads, it needs a political fix, not a legal one

Without doubt, negotiation on GST compensation will be contentious. Time for Centre and states to show true leadership and salvage it

Acrimony between the Centre and states has brought the Goods and Services Tax (GST) to a crossroads. Down one path lies the breakdown of the GST, the re-balkanization of India into segmented markets, and a damaging rupture in Centre-state cooperation, fiscal and beyond. Down the other path lies the rehabilitation of the GST so that it can deliver on its initial promise. The preferred choice is clear, almost obvious. The dispiriting news is that it requires good faith on both sides, which seems to be in short supply.  

The starting point is the obvious one. Covid-19 is a historically unprecedented economic shock, perhaps the greatest since the First War of Indian independence in 1857. The solution cannot, it must be emphasised, be legal-cum-technical, stemming from the letter of the law. It must be political and based on the spirit of the law.

But how did we arrive at such an impasse? History records that it was the Centre that committed the original sin. First, in 2017-18, the Centre played fast and loose with the IGST settlement, delaying and reducing the amounts paid to the states. Second, in 2018, it did something similar, transferring the compensation cess to its own coffers, the Consolidated Fund of India, rather than to the compensation kitty. And, of course, almost six months into Covid and the financial year, GST compensation has still not been provided to the states. Although the first two sins were eventually corrected, they nevertheless left a deep residue of distrust in the GST discussions.

That said, the Centre is attempting to find a solution to the current dispute. Yes, its proposals deviate from the pledge to provide states with a guaranteed 14 per cent annual increase in GST revenues. But Covid-19 is the biggest economic shock, a black swan event. As a result, fiscal revenues have been devastated; the money to pay out the guarantees is simply not there.

Let us be clear: no GST agreement could have catered in advance to a Covid-type situation, and no agreement should have even tried to do so. Covid is the sort of crisis which forces governments to throw the rule book out.

 

 

Given this situation, the Centre’s proposal last week could be interpreted as a valiant effort to square the original agreement with the new, fiscally-straightened reality. In effect, the proposal envisages paying this year’s promised amount over time, as the GST revenues become available, financed by the imposition of new cesses. But given that the states need revenue now, and given the Centre’s sins in the past few years, the states have dug in their heels, reacting negatively to the Centre’s proposals.

Beyond these concerns, the proposal is also technically flawed. Given the large shortfall in GST collections, some government entity will need to borrow: the plan calls for this to be done by the less-able states, rather than the more-able Centre. Moreover, the proposal would add to the complexity of the GST by perpetuating cesses, far past the five-year terminal date. And it would complicate the management of state government finances by specifying what and how much borrowing will count towards state fiscal responsibility targets.

Clearly, another strategy is needed. In fact, there is a simple solution, which is easily available, provided both sides exhibit a modicum of good faith. The Centre must make the first move, come forward and accept the important spirit of the compensation deal, namely that it alone has responsibility to meet the states’ shortfall. That burden must not be transferred on the states, especially at a time of extreme fiscal hardship.

In return, the states too must act in good faith. They cannot insist on the letter of the law, demanding 14 per cent increases at a time when revenues everywhere will decline, by perhaps 20 per cent. Yes, the Centre has a responsibility to the states. But the extent of that responsibility must be assessed in line with fiscal realities. To insist on 14 per cent compensation when revenues everywhere will decline by 20 per cent is also an act of bad faith.

The Centre and the states should therefore get together and negotiate a one-off political solution, consistent with the spirit of the original agreement but calibrated responsibly to the unforeseen, unforeseeable situation that is Covid-devastated India.

The agreement would have three parts. First, for fiscal 2020-21, the states would receive a compensation of X per cent, where X is somewhere in between –Y per cent (the expected shortfall in GST revenues) and 14 per cent, the original compensation guarantee. Second, for 2021-22, the Centre should commit to going back to the 14 per cent commitment, recognising that this is the last year of the compensation window. And finally, to the extent that the agreed compensation exceeds collections, the Centre, not the states, should secure the needed amounts through borrowing in financial markets.

Many possible formulas for X could be envisaged. For example, the Centre and states could agree that X should be: the same level of compensation as last year; equal to the average of –Y per cent and 14 per cent; or sufficient to ensure that state GST receipts are the same as last year.  

Without doubt, negotiation on GST compensation will be contentious. But this is a moment when the leaders at the Centre and states must show true leadership for the sake of the country. And it is the top political leaders, not attorney generals or bureaucrats, who should be sitting together and settling this thorny issue of compensation.

They can do it, they must do it, for the stakes are immense. Because if a compromise is not reached, one of the major, potentially still path-breaking, reforms of the last 20 years could rapidly come undone. And the country will have gone down that first path of folly and devastating loss.

The writer is Professor at Ashoka University, and former Chief Economic Adviser to the Government of India