Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment;
Key phrases: Goods & Services Tax, Services Tax Council, GST (Compensation to States) Act, 2017
Why in news?
- States are seeking an extension of GST compensation for five more years.
What is GST Compensation and its legal backing ?
- The introduction of the Goods & Services Tax (GST) required that States and Union Territories (with Legislature) should subsume their sovereignty in a GST Council, which brought forth the issue of loss on account of migration from Value Added Tax/Sales Tax to GST.
- Any mechanism to remedy this loss should be backed by legislature.
- Hence Sec18 of the Constitution (101st) Amendment Act, 2016 prescribes: “Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years.”
- Accordingly, the Parliament enacted a law — GST (Compensation to States) Act, 2017 which prescribes that the financial year 2015-16 shall be taken as the base year for the purpose of calculating compensation and States were assured of a 14 per cent growth in revenues every year.
How is it funded?
- In order to mobilise resources for compensation, a cess is being levied on such goods, as recommended by the Goods and Services Tax Council, over and above the GST on that item. It is called compensation cess. As on date, compensation cess is levied on products such as pan masala, tobacco, aerated waters and motor cars apart from coal.
Who pays compensation to whom? When?
- The consumer is required to pay for compensation. It is collected by the Centre which releases it to States. The proceeds of the compensation cess will be credited to a non-lapsable fund known as the Goods and Services Tax Compensation Fund in the public account.
- All amounts payable to the States as compensation will be released bi-monthly, provisionally, from said fund against figures given by the Central accounting authorities.
- Final adjustments will be done after receiving audited accounts of the year from the Comptroller and Auditor General of India.
For how long will it be paid?
- As per the the law, it would be paid for five years from the date GST came into effect; i.e. till June, 2022. However, cess will continue to be levied for repayment of loan taken to compensate States during FY21 and FY22.
What is back-to-back loan arrangement for Compensation?
- The economic impact of the pandemic led to higher compensation requirement due to lower GST collection and, at the same time, lower collection of GST compensation cess. The issue of GST Compensation to States was deliberated in the 41st and 42nd GST Council meetings.
- Accordingly, in FY21, the Centre had borrowed ₹1.1-lakh crore under a special window and passed it on to the States as back-to-back loan. This was meant to help States meet the resource gap due to short-release of compensation on account of inadequate balance in the compensation fund. The Centre says it is committed to releasing full GST Compensation to the States/UTs as per law for the transition period by extending the levy of compensation cess beyond 5 years to meet the GST revenue shortfall as well as servicing the loan borrowed through a special window scheme.
- Subsequent to deliberations in the 43rd GST Council meeting, the Centre has borrowed ₹1.59-lakh crores from the market through a special window in the current fiscal and passed it to the States/ UTs as a back-to-back loan, as was done last year.
What is Back-to-Back Loan Arrangement?
State Governments in India cannot access external sources of finance directly. The 12th Finance Commission recommended the transfer of external assistance to State Governments in India by the Union Government on a ‘Back-to-Back’ basis. This recommendation was accepted by the Government of India for general category states and the arrangement came into effect from April 1, 2005. For special category states ( Northeastern states, Uttarakhand, Himachal and J&K), external borrowings are in the form of 90 per cent grant and 10 per cent loan from the Union Government.
Passing loans on ‘Back-to-Back’ basis to State Governments implies that States would face identical terms and conditions (including concessional interest rates, grace period and maturity profile, commitment charges and amortization schedules) on account of their access to finance from bilateral and multilateral sources, as is faced by the Union Government.
This arrangement entails exposure of States to uncertain movements in international rates of interest (as multilateral agencies viz. IBRD benchmark their interest rates to a reference rate viz. the LIBOR) and currency exchange rates.
As per the ‘Back-to-Back’ loan transfer arrangement, states would have to face currency risk since principal repayments and interest payments on such loans to external agencies are designated in foreign currencies. In case of adverse exchange rate movement(s) larger rupee provisions may be required to meet debt service obligations that may negatively impact the fiscal health of the state concerned.
Thus, direct exposure to interest risk and currency risk carry implications for debt service burden and therefore for the fiscal status of State Governments in India. Capacity building in financial system of State Governments is required to ensure that debt is prudently managed.
Source: Arthapaedia
Why are States demanding an extension of the compensation?
- States say their revenue situation is yet to improve on two counts — due to the introduction of the GST and because the pandemic has affected revenue collection. At the same time, their expenses have gone up and they expect higher deficit as revenue growth is low. Considering all these, States are seeking an extension of compensation for five more years. Any decision, in this regard, has to be taken by GST Council.
Way Forward
- Keeping into consideration that most of the social development subjects
like health and education largely lie with the state ,it is imperative that
states be kept compensated for extended duration.
Any new system takes time to get smoothen as is evident in this issue - Besides this states are required to improve their revenue collection amount and base so that its dependence on centre is reduced to some extent .
- In Back-to-Back system states should improve their financial systems so that debt burden does not become unmanageable.
- Both Centre and States should work in coordination in true spirit of cooperative federalism
Source: The Hindu BL
