Promise broken, states broke

The mechanism to raise the funds to provide the compensation was the GST Compensation Fund. The mechanism was in aid of the obligation, not that the obligation was subject to the mechanism — a point conveniently ignored by the Finance Minister and her officials.

GST has become the Grim Struggle for Taxes. Even amidst a pandemic-devastated economy, that was already on a rapid slide, the Central government should have exhibited greater statesmanship. That it did not, has revealed its intentions.

Centre must aid States

Why do I say that the Central government should have gone to the aid of the state governments and not the other way around? Because, the powers of the two are very different:

– the Central government can borrow as a matter of right; state governments can borrow only with the prior approval of the Central government;

– the Central government, as the sovereign, can command the lowest rate for its borrowing; state governments borrow at higher rates and there are differential rates among state governments;

– the Central government is entitled to receive the profits of the RBI as dividend and had, on a recent occasion, arm-twisted the RBI to declare a dividend of an amount larger than what the RBI was willing to give; state governments have no claim over the RBI’s profits; and

– the Central government can monetise its deficit, that is, ask the RBI to print money and give it to the Central government; state governments do not have that sovereign power.

Therefore, in a time of financial crisis, the state governments need help. In 2020-21, every state government is expected to exhaust its borrowing limit of 3 per cent of the GSDP. They pleaded for more headroom and got a miserly 0.5 per cent which most state governments — maybe all — will utilise this year. Any borrowing beyond that will be burdened with conditionalities that no state government is prepared to fulfill, especially this financial year.

Compact based on Trust

The GST agreement was a compact between the Central government and the state governments arrived at after years of discussion. The compact was based on trust. There is the letter of the law and there is the spirit underlying the law. States were persuaded to yield to a Council (in which the Central government has a veto) the power to levy VAT on goods — the kamadhenu that filled the states’ coffers — and many other taxes that contributed to the kitty, such as Entry Tax. In return, the Central government promised them that (1) GST revenues will grow handsomely as was the case when VAT replaced sales tax and (2) if the revenue growth fell short of 14 per cent per year, in the first five years, the Central government would compensate them fully for the shortfall.

The obligation to compensate the states was written in the law. The mechanism to raise the funds to provide the compensation was the GST Compensation Fund. The mechanism was in aid of the obligation, not that the obligation was subject to the mechanism — a point conveniently ignored by the Finance Minister and her officials.

The Fund could be in surplus or deficit in any year or at the end of five years. If it was in surplus at the end of five years, 50 per cent of the surplus would be transferred to the Central government. If it was in deficit, what was to be done? The point was debated at length in the GST Council, especially at the 7th, 8th and 10th meetings. The discussion was concluded at the 10th meeting on February 18, 2017, and para 6.3 of the signed minutes recorded thus:

6.3. The Hon’ble Minister from Telangana stated that the Compensation Law should provide that if money fell short in the Compensation Fund, it could be raised from other sources. The Secretary stated that Section 8(1) of the draft Compensation Law provided that cess could be collected for a period of five years or such period as may be prescribed on the recommendation of the Council. He stated that this implied that the Central Government could raise resources by other means for compensation and this could then be recouped by continuation of cess beyond five years. He stated that the other decisions including the possibility of market borrowing for payment of compensation was part of the Minutes of the 8th Meeting of the Council (held on 3rd and 4th January, 2017) and need not be incorporated in the Law. The Council agreed to this suggestion.” (emphasis mine).

Unambiguous Decision

There can no doubt what the decision was. The Central government could raise resources by other means for compensation including the possibility of market borrowing for payment of compensation. No amount of casuistry can change the record.

The ‘two options’ given by the Centre to the states to borrow are an act of deceit. There is a hole in every state’s revenue budget for the current year. The borrowing will fill the hole but will be shown as a debt in the capital account of the state, which the state has to service by paying interest and eventually repay the debt. If the state does not borrow and the Centre will not provide the compensation, the hole will remain a hole and, inevitably, the state will cut its capital expenditure or welfare expenditure in the current year — neither of which is desirable.

The states are right in rejecting the ‘two options’ and asking the Centre to provide the resources to fill the gap. Will the Centre rise to its responsibility or play the game of ‘my way or the highway’?

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