The idea of ending fratricidal tax competition among States and creating a common market in India across State borders was mooted by the Bhairon Singh Shekhawat Committee (1995). If sovereign nations of Europe could do it, we could do as well. So the Goods and Services Tax (GST) was implemented from July 2017 with the underlying vision of “one nation, one tax, one nation, one market.” The States had agreed to an all-India common slab for particular items, thereby surrendering the power to tax the items at a rate of their own choice.
GST changed the principle of indirect taxation from originating/producing States to the destination/consuming States. The benefit of GST collection accruing to the State, where the final sale takes place, was seen as a loss by the producing States. The GST took so long to materialise mainly because the States were apprehensive not just about the loss of power to tax but also of revenue. It was challenging to convince all the Governments to agree to a common tax rate on a particular item, superseding multiple Central/State/local taxes like Central Excise Duty, Central Sales Tax, Value Added Tax, Sales Tax, Purchase Tax, Tax on Works Contracts, Entry Tax, Octroi and so on, which were discontinued and subsumed in GST.
To assuage the anxieties about potential loss of revenue, a revenue protection guarantee backed by law was agreed to. The revenue to be protected is calculated by assuming 14 per cent per annum growth over the tax collection in 2015-16 from the taxes subsumed in the GST. Accordingly, the GST (Compensation to States) Act, 2017 mandates the Centre to levy a GST compensation cess over and above the GST. The cess is at present levied on certain luxury and sin goods such as cigarettes and tobacco products, paan masala, caffeinated beverages, high-end passenger vehicles and so on. The guaranteed compensation period is five years from the commencement of GST (July 1, 2017).
In 2018-19, the Centre had collected Rs 4,57,535 crore as Central GST, Rs 28,947 crore as Integrated GST and Rs 95,081 crore as GST compensation cess. For 2019-20, the corresponding figures (all provisional) are Rs 496,699 crore, Rs 9,186 crore and Rs 95,551 crore. A total amount of Rs 81,141 crore was released as compensation to States in 2018-19 but the compensation requirement for 2019-20 has nearly doubled to Rs 1,65,000 crore. GST revenue was already below target even before Covid-19 and the pandemic is set to further enhance the compensation requirement for 2020-21 and beyond. The States’ monthly protected revenue, which was Rs 49,020 crore for 2018-19 and Rs 55,882 crore for 2019-20, has risen to Rs 63,706 crore in 2020-21.
A prolonged lockdown, suspension of train, metro and air services, and subsequent behavioural changes are expected to seriously dent demand for goods and services in various sectors, especially exports, tourism, hospitality and outdoor entertainment. Estimates of likely compression of demand vary widely depending on the observer’s outlook, pessimistic or optimistic.
The Government expects to collect a total GST of over Rs 1,00,000 crore per month but GST collections during April-July have been Rs 32,172 crore, Rs 62,151 crore, Rs 90,917 crore and Rs 87,422 crore. In FY21, GST shortfall left uncovered by existing compensation cess is assessed to be Rs 2,35,000 crore. The scope for an extraordinarily large increase in GST compensation cess to cover the whole GST revenue loss is limited as it may adversely affect sales.
When the States were given a five-year revenue protection guarantee in 2017 with an assured 14 per cent increase, such a large reduction in revenue could not have been foreseen. Hence, it can be argued that Covid-19 is an “Act of God” and the States should not insist on getting fully compensated.
In the law of contracts, the courts refuse to enforce a contract when the performance becomes “impossible” (Section 32 of the Indian Contract Act, 1872). What is impossible is open to judicial interpretation. In the Tsakiroglou vs Noblee Thorl case, defendants had contracted to supply Sudanese peanuts to Hamburg but the Suez Canal was closed, blocking the customary shipping route (In July 1956, the Egyptian government nationalised the Canal earlier owned by UK and France causing a crisis). The defendants sought to renege on supply commitment, citing the canal closure. The House of Lords held that peanuts could have been transported via the Cape of Good Hope, a four-time longer alternative route. It would have become commercially onerous but not impossible! In the Alopi Parshad & Sons, Ltd vs Union of India case, the Supreme Court did not allow a supplier of ghee to wriggle out of his pre-war contract merely because World War II had upset his whole economics. Increased commercial difficulty did not amount to impossibility to perform, the court held.
Most contracts, therefore, have a standard clause of “force majeure” detailing extreme situations of war, natural calamities, change of laws or other governmental actions and so on. But the compensation to States for GST revenue shortfall is not part of any contract and not amenable to examination with the lens of “force majeure.” It is basically a legal commitment arising out of a political settlement to arrive at a common taxation framework in a federal polity. The obligation flows from an Act of Parliament. The Parliament can very well change, prospectively or retrospectively, or even scrap the 2017 Compensation Act. The amended law can reduce 14 per cent assured growth to a lower level or introduce additional fiscal measures to compensate the States.
In the present circumstances, a review of the 2017 Act could theoretically be an option but that can potentially re-open settled issues on GST.
The financial interests of the Centre and States are not adversarial but closely inter-connected. The States’ dependence on Central financial support is significant. Central transfers to States constitute about 20 per cent of total Central government expenditure. In 2017-18, the combined expenditure of Centre and States was about Rs 45 lakh crore — Rs 21 lakh crore by Centre (including transfers to State governments of Rs 4 lakh crore) and Rs 28 lakh crore by the States (including expenditure against transfers from Centre of Rs 4 lakh crore). States realise that the Centre itself is facing financial crunch and insisting on full GST compensation as promised can potentially mean cut in other discretionary Central assistance to States if the Centre is asked to go beyond compensation cess to cover the shortfall.
On August 27, the GST Council discussed the vexed issue of compensation to States for huge loss of GST revenue. States have been given two options to borrow additional money. Borrowing is nothing but deferred taxation. Today’s government borrowing is tomorrow’s tax. May be tomorrow’s tax will become tomorrow’s borrowing and day after tomorrow’s tax and so on. More than 20 per cent of total government expenditure is financed through borrowings. This is how the governments have been piling mountains of debt and there is no visible exit from this trap, not in the immediate future, certainly not in crisis time. Crisis justifies borrowings, to be repaid/serviced in better times.
If GDP at factor cost (proxy for total base of indirect taxes) is assumed to be Rs 160 lakh crore and 60 per cent of this GDP pays average GST of 15 per cent, then the GST revenue should be Rs 1.2 lakh crore per month, almost 10 per cent of GDP. The revenue from taxes subsumed in the GST was about six per cent of GDP in 2016-17. Obviously, GST revenue is below expectation and potential. Strong facilitation and anti-evasion measures can reduce the revenue loss and concomitant compensation requirements.
The great federal bargain on GST among governments is facing an acid test. The hard-won political consensus needs to be preserved and nurtured and no cost is big enough to make GST a grand success, by removing the pending irritants, mostly on the implementation side.
(The author is an IAAS officer, superannuated as Special Secretary, Ministry of Commerce and Industry)