The gap between GST cess collections and the revenue shortfall faced by States for implementing the Goods and Services Tax (GST) could snowball to anywhere between ₹5 lakh crore to ₹7 lakh crore by June 2022 from the ₹2.35 lakh crore estimated for this year, the Fifteenth Finance Commission is learnt to have projected in its report.
The Commission, which finalised its report proposing a framework for sharing revenues between the Centre and the States for the next five years on October 30, is learnt to have recommended a unique fiscal glide path for each State for the period 2020-21 to 2025-26, in a separate volume dedicated to States.
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Given the uncertainty created by the pandemic and the slowdown in the economy that pre-dated the COVID-19 virus, the panel, whose report will be submitted to President Ram Nath Kovind on Monday, has had to rely on variable growth projections for each of the five years rather than assuming a steady growth trend.
The panel has also delivered on its more unusual terms of reference, including the question of creating a separate mechanism for funding defence and internal security proposed by the Centre, citing inadequate Budgetary provisions for large capital outlays needed for complete defence preparedness.
“The Commission has examined and responded to the Defence Ministry’s proposal to set up a non-lapsable fund for security-related expenditure, whether it should be funded by a cess or a surcharge, and supplemented by monetisation of surplus defence land, issue of tax-free defence bonds and disinvestment of defence public sector units,” said an official, pointing to the additional pressure on the Centre’s finances due to the fall in revenues and the flailing economy.
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GST concerns
Unless there is a sustained rise in GST collections over the next 20 months (till June 2022), the Commission has projected that the gap between the GST cess collections used to recompense States and their compensation dues could accumulate to a significant sum of “between ₹5 lakh crore to ₹7 lakh crore”, said the official privy to the Commission’s assessment of States’ fiscal positions.
The resolution and the modalities adopted for the payment of GST compensation dues to States would significantly impact the fiscal consolidation roadmap for India’s general government debt, the official said.
While the revenue shortfall for States is pegged at ₹3 lakh crore this year, GST cess collections are expected to be just ₹65,000 crore, on account of the sharp contraction in the economy that was already slowing down before the COVID-19 pandemic and was exacerbated by the lockdowns. The Centre has allowed States to borrow from the market to meet part of the shortfall, with the assurance that loans will be serviced and repaid from future GST cess collections.
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The Centre had promised compensation for revenue losses to States on account of giving up their indirect taxation powers and switching to the GST regime, for the first five years of the new tax regime launched in July 2017. A compensation cess was levied on so-called ‘sin’ and ‘demerit’ goods to finance this payout to States over the same period.
Early last month, the GST Council extended the levy of compensation cess indefinitely beyond June 2022 till as long as it is necessary to settle unpaid compensation dues that accrue to States till June 2022. Last month, the Commission’s chairperson N.K. Singh had told The Hindu that the levy of compensation cess under the GST regime may have to be continued till the end of 2025-26 to bridge States’ unpaid dues.
Projection challenges
Unlike the Fourteenth Finance Commission which had assumed a nominal GDP growth rate of 12.5% for the full five-year remit of its recommendations, its successor has instead made separate growth projections for each year. The Commission had assumed a nominal GDP growth rate of 11% for 2020-21.
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The Commission had earlier submitted an interim report for 2020-21 , citing the difficulties in making credible projections for a five-year period at a time when the economy was slowing down after the execution of major structural reforms such as the implementation of the GST, demonetisation and the insolvency and bankruptcy code for resolving stressed loans.
Devolution tweaks
Asked to base its recommendations for devolutions to States based on Census 2011 data instead of the 1971 census relied on by previous Finance Commissions, the panel has sought to address concerns of the Southern States about losing out due to better management of population growth in recent decades. It had proposed the use of Total Fertility Ratio as an additional parameter to offset any disadvantage faced by States with lower populations, and is expected to persist with this approach, the official said.
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The Commission has factored in the greater demand placed by the pandemic on both the Centre’s and States’ finances in a ‘rational and balanced manner’, he added, when asked if States' share of revenues could be lower than the 42% recommended by the previous Commission. This was pared down to 41% for 2020-21, following the dissolution of Jammu and Kashmir last year.
The Commission has also looked at possible performance-based incentives for States to pursue critical reforms, especially in the power sector where unpaid liabilities of State discoms remain a deterrent. “The UDAY scheme launched for this purpose hasn’t made much progress,” the official pointed out.
