Goods and Services Tax (GST)

The way out on GST compensation


From UPSC perspective, the following things are important :

Prelims level : GST compensation cess

Mains level : Paper 3- GST compensation

The economic disruption due to pandemic has made the issue of GST compensation bone of contention between the Centre and the States. This article argues that it is the GST Council and not the Centre which is responsible to find ways to raise the revenue in such a situation.

GST revenue loss and role of the Centre

  • Due to global pandemic, one significant area of loss of revenue to both the Centre and the states is GST.
  • The states have the comfort of assured 14 per cent growth through the compensation mechanism.
  • The Centre has no such guarantee.
  • The Compensation Act mandates compensating the states for revenue loss on GST implementation from the Compensation Fund.

Role of GST Council

  • The course of action to be adopted in the event of the amount in the Fund falling short of requirements was discussed at length in the GST Council.
  • The late Arun Jaitley, then chairman, had, in the 8th meeting, assured that “in case Compensation Fund fell short of the compensation payable, the GST Council shall decide the mode of raising additional resources including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years”; the Council had agreed to this suggestion.
  • Quite clearly,  it is the Council and not the Government of India that shall decide the mode of raising additional resources in the event of a shortfall and this is reflected in Section 10(1) of the Compensation Act.

Why it makes sense for the States to borrow

  • It is argued that borrowings by the Centre or by the states make no difference in the context of fiscal discipline.
  • The argument further adds that the Centre should borrow in view of its higher borrowing and debt-servicing capacity and its ability to borrow at lower rates.
  • Article 292 (1) mandates that the Centre can borrow on the security of the Consolidated Fund of India (CFI).
  • However, the idea of providing compensation to the states from the Consolidated Fund of India was not agreed to in the Council, it is difficult to agree with the suggestion that GoI borrows on the basis of the said CFI.
  • Large borrowings by the Centre would push up the bond yield rates, pushing up bond yield of the states setting off a spiral leading to hike in the interest rates for businesses and individuals.
  • The states’ borrowing would become costlier if the Centre were to borrow for this purpose.
  • The borrowing capacity of the states, too, is not very inferior.
  • The RBI study of state finances shows that the debt receipts of all the states as a percentage of GDP has hovered between 2.4 per cent and 3.6 per cent during the last four years.
  • The states have on the average borrowed just about 1.25 per cent of the GSDP thus far.
  • The states are consistently borrowing less than they can borrow (legally and financially).
  • The cost of state borrowings for this purpose can be considerably lowered if arranged through a special window.
  • The Centre has already breached the budgeted borrowing limits for the current year.
  • Thus it makes sense for the states to borrow.

Borrowing options for the States

  • There are two ways in which the States can borrow.
  • 1) Borrowing the entire shortfall in the revenue.
  • 2) Borrowing only the shortfall attributable to GST implementation with the remaining shortfall to be made good from the Cess Fund post the transition period.
  • Certain conditionalities have been relaxed for option-1.
  • However, borrowing the entire shortfall, as envisaged in option-1, will hurt both the markets and the private sector, pushing up the interest rate.
  • The single window under option-1 being arranged by the Centre and the entire debt being serviced from future cess receipts will ensure that the cost remains close to the G-sec rate.
  • Moreover, there will be no variation in the interest rate as between the states.


The states should come forward and work with the Centre in the true spirit of cooperative federalism that the Council has come to be known for these past few years.

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