The GST, implemented on 1 July 2017, unified India’s fragmented indirect tax system into a single, destination-based tax, aimed at creating a ‘one nation, one tax’ System.
Rationale behind the GST (Compensation to States) Act, 2017
GST subsumed major state taxes (VAT, entry tax, octroi). To prevent short-term revenue loss, the Act assured 14% annual revenue growth for 5 years (2017-22).
Addressing Loss of Fiscal Autonomy – Compensation ensured states’ fiscal stability during structural shifts.
Cooperative Federalism- States agreed to adopt GST in exchange for legal assurance of compensation from the Centre.
Creating Predictability in Budgeting – Guaranteed revenue helped states plan welfare schemes, salaries, and capital projects without fear of instability.
Compensation Fund Mechanism- A dedicated GST Compensation Cess (on luxury/sin goods like tobacco, coal, automobiles) was created to finance the compensation pool.
Impact of COVID-19 on the GST Compensation Fund
According to the 41st GST Council meeting, states projected a for 2020-21. With an estimated , the shortfall in the GST compensation fund was expected to be .
was due to GST implementation-related revenue gaps, and
was attributed to the COVID-19-induced economic shock
The Centre admitted an unprecedented shortfall, stating it could not fully compensate states from the fund.
Borrowing Controversy
The Centre asked states to borrow via RBI under two options.
Many states (Kerala, Punjab, Chhattisgarh) argued that the borrowing burden should lie with the Centre, not states.
Breakdown of Consensus in GST Council – For the first time since 2017, the Council saw voting instead of consensus. States alleged weakening of cooperative federalism.
Increased Fiscal Stress on States – Shortfalls forced states to cut capital expenditure, delay welfare payments, and increase market borrowing.
States demanded extending the compensation period beyond June 2022 due to pandemic losses
Strengthening the fiscal framework, improving tax buoyancy, and enhancing transparency in compensation mechanisms are essential to restore trust in India’s cooperative federalism.