Centre’s decision to invoke “Force Majeure” clause for non-payment of State’s due GST compensation for FY 2020-21 is morally unacceptable. The two borrowing options that places the onus of extra borrowing on states to compensate for the revenue shortfalls is not only unconstitutional under 101st constitutional amendment Act, 2016 but also a clear blow to the India’s federal structure in future, going ahead.
The experience from the last six
months in the way states are handling the pandemic clearly indicates that they
are truly “laboratories of democracy”
as paraphrased by former U.S. Supreme Court Justice Louis Brandeis. However, the constitutionally defined
federalism in India is “quasi federal” in nature with existence of strong
unitary bias and asymmetry in the way it works. Be its recent revoking of
Article 370 by division of Jammu and Kashmir into two Union Territories without
securing State government’s consent or recent passage of the three
controversial bills on agricultural reforms; the actions of the central
government have always in the past indicated towards its top-down approach,
centralisation and micromanagement from above.
Amid the growing rhetoric of strengthening
spirit of “cooperative federalism” in
India to generate better results to some deep rooted economic problems, the
Centre is slowly taking away sovereignty of state governments. One shining
example of this is introduction of GST in July 2017 which has seized the fiscal
autonomy of states; thus making their very survival dependent on the grace of
the Union with central government always falling short of providing
compensation on time. Unfortunately, this problem is getting worse at a time
when every Indian State is battling with COVID-19 crisis with their revenue
streams drying down.
The Goods and Services Tax (GST)
regime was implemented on the promise that if States faced any revenue deficits
after its introduction, the Centre would make up for it in the first five years
(2017-22). As part of the grand federal bargain, the growth rate of the states’
GST revenue was fixed at 14% from the amount of collections in 2015-16.
Accordingly it was agreed that if the states’ GST collections fall below 14%
annual growth, the central government would compensate them for the revenue
shortfall through a fund financed through a levying a compensation cess on the
luxury and sin items in the 28% GST slab. It was on the basis of this commitment
that States sacrificed their constitutionally granted right of taxation and
extended their support for a nationwide GST.
The outcome of the recent meeting
that was held on 27 August 2020 to discuss possible ways to ensure fair GST
compensation to states was unexpected. Centre not only reneged on its promise
to provide for the revenue shortfalls to state governments but also maintained
that, of the projected shortfall of about Rs. 2.35 lakh crore, only Rs. 97,000
crore was due to the implementation of GST. The remaining amount, that is,
Rs.1.38 lakh crore was attributed to the COVID-19 pandemic, which according to
the finance minister, was an “act of
God,” a crisis independent of the GST. Thus, Centre invoked “Force Majeure” escape clause and stated that the shortfall is due “Act of
God” which is beyond anyone’s control and offered two borrowing options to
states in order to bridge their revenue shortfall.
-The two borrowing options
In the first option, Centre would
coordinate the combined borrowing by the states through a special window, in
consultation with RBI, to borrow Rs.
97,000 crore, to cover the shortfall in revenues resulting from “GST implementation” alone. The cost of
servicing this debt (interest and principal) would be covered from future
revenues from the compensation cess extended beyond 2022. Further, an
unconditional relaxation of 0.5% in borrowing limit under FRBM Act would be
provided to states. Under the second option, the states could borrow from the
market to raise the entire Rs. 2.35 lakh crore, but the interest cost here
would have to be borne by states, and only the principal would be serviced by
the compensation fund. In both the options, the principal amount will be
serviced from the Cess Fund.
Of the two options presented by
the Centre, option-1 seems to be superior, as on one hand, the special RBI
window under option-1 will not only reduce the cost of borrowing but will free
the states from any additional debt burden as whole revenue shortfall would be
borne by the compensation cess extended beyond 2022. However, in the second
option, not only States will have to go for market borrowings at higher rate of
interest which would not be covered by extended compensation cess, but also,
out of Rs. 2.35 lakh crore borrowing, states will not be allowed to treat the
borrowing in excess of Rs 97,000 crore as outside of their normal debt
financing programme. It is in this light that most of the BJP ruled states have
agreed for first option; however, many non BJP states have rejected both the
options.
Who should borrow; Centre or
States?
-The Centre’s view
To this end it is important to
analyse whether it is morally right on the part of the Centre to not to borrow
itself, rather asking states to undertake an additional debt burden on
themselves in lieu of the compensation payment that they are entitled to
legally. The justification that the Centre has given for not borrowing is that
it has already breached the fiscal deficit target in the first four months of
the current fiscal year (In April-July period only, fiscal deficit reached Rs
8.21 lakh crore against annual budget estimate of 7.96 lakh crore). Further,
Centre has already announced to borrow additional Rs 4.2 trillion from the
market ; thus pushing estimated gross market borrowing for the current year from
Rs. 7.80 lakh crore as per BE 2020-21
to Rs. 12 lakh crore. Thus, it is
financially imprudent on the part of the Centre to borrow additional amount to
finance GST revenue shortfall; as any further borrowing would push up the yield
rates on central government securities which act as a benchmark for interest
rates for businesses and individuals. Centre is also placing the view that
states should borrow as they have more headroom to do so as their borrowing
limit under FRBM act has already been raised from 3% to 5% of GSDP for FY21 as
part of COVID relief package in May 2020.
Another argument given by the Centre is on account of prolonged recession (economy started slowing down in 2019 itself, followed by COVID induced recession in 2020), because of which compensation fund has not only failed to mobilise adequate revenues to compensate the states in full but also is left with no past surpluses to cover any shortfalls. To illustrate this, the total amount of compensation released for 2019-20 was Rs 1,65,302 crore whereas the amount of cess collected during the same year was only Rs 95,444 crore. Thus, even the shortfall for the last year (2019-20) was covered through the excess GST compensation cess collected during 2017-18 and 2018-19; thus leaving no left surpluses to compensate states for the current fiscal year.
-The States’ view
States argue that Section 18 of the 101st Constitutional amendment Act, 2016 makes them legally
entitled to receive compensation for the loss of revenue arising out of
implementation of the GST for five years, irrespective of the collections under
the cess. The Centre not doing so would be considered as reneging on its
commitment. States are constantly maintaining that under federal structure,
they expect the Centre to demonstrate empathy, especially at a time when they
are at the forefront of battling pandemic with battered budgets. They consider
that Centre invoking “Force Majeure”
clause at this point of time is completely immoral and unethical.
Next argument given by States is
that if borrowing is the only solution to cover shortfalls, then Centre is
better placed to do so as they have extra resources available with them in the
form of more elastic and buoyant taxes at their disposal such as income tax,
corporation tax and customs duties which are outside the ambit of GST. In
addition, Centre has access to more non-tax revenues such as dividends from the
RBI and Central PSUs. Further, Centre, along with RBI has better access to the
bond market and can raise the money at more competitive interest rates.
What’s the Solution- Diving into "Consolidated Fund of India"?
Many states have argued that in
the first two fiscal years after introduction of GST, i.e. in 2017-18 and
2018-19, when the scheme worked smoothly and there were surpluses in the cess
fund (GST compensation cess exceeded the amount that had to be paid to States),
the Central government absorbed that surplus to bolster its own tax revenues,
and shifted the money to Consolidated
Fund of India (CFI), rather than keeping it aside for any future shocks.
Even the undistributed portion of Integrated GST (IGST), which at times was
over Rs 1 lakh crore was deposited in the public account of Government of
India. Now, symmetry demands that when the GST compensation fund is in deficit,
Centre should meet the GST revenue shortfall through dipping into its Consolidated Fund of India.
Nonetheless, from the perspective
of fiscal discipline and credit rating downgrades, since the general government
debt will rise regardless of who borrows, thus the important question is not
about Centre or State borrowing, but about which is the most efficient and
sustainable option for the economy as a whole. To this end, no doubt, Centre is
better placed to borrow with good hold over bond and securities market and have
more resources at its disposal in the form of buoyant tax and non-tax revenues.
Further, to alleviate any apprehensions of rise in long term G-sec yields
consequent to any Central government borrowing, RBI can carry out more rounds
of Operation Twist or its related
variants to keep the overall borrowing cost for businesses at affordable
levels. Besides this, effective measures needs to be undertaken by Centre towards developing a
deep and liquid bond market, so that states are able to borrow on better terms,
if needed. Last but not the least, the need of the hour is to bring the economy
back on a sustainable growth trajectory, so that the GST compensation fund that
is at its record low can be revived again to compensate for any revenue
shortfalls; thus obviating the need for any future borrowing requirements,
going ahead.
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