Q12. Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions?

Model Answer:

Introduction

The GST (Compensation to States) Act of 2017 was enacted to address the concerns of states regarding potential revenue loss due to the implementation of the Goods and Services Tax (GST). The primary rationale behind the Act was to ensure a smooth transition to the new indirect tax regime and maintain the fiscal stability of states. 

Body

Rationale Behind the GST Act

• Compensation for Revenue Loss: The Act guarantees states compensation for any loss in revenue that may arise due to the introduction of GST. This compensation is calculated based on the difference between the projected revenue and the actual revenue collected by a state.
• Transition Period: The Act established a transition period of five years (2017-2022) during which the compensation would be provided.
• Compensation Fund: A GST Compensation Fund was created to pool the resources required for providing compensation to states. This fund is primarily financed through the levy of a GST compensation cess.
• Protected Revenue Growth: The Act assumes an annual growth rate of 14% in the GST revenue of states during the transition period. If a state's revenue falls short of this projected growth, the difference is compensated by the Centre.

Impact of COVID-19 on GST Compensation Fund and Federal Relations

The COVID-19 pandemic has significantly impacted the GST compensation fund and created new federal tensions between the Centre and states. The nationwide lockdown and economic slowdown led to a sharp decline in GST collections, straining the resources available for compensation.

Key Impacts:

• Increased Compensation Requirements: The pandemic-induced economic downturn resulted in a substantial increase in the compensation requirements of states. This is because the GST collections fell far short of the projected revenue growth during the transition period.some text
  •  In the fiscal year 2021-22, the central government disbursed ₹1.59 lakh crore as GST compensation to states, but states like West Bengal and Punjab faced difficulties in meeting their revenue expectations.
• Resource Constraints: The Centre faced significant resource constraints in meeting the increased compensation requirements. This led to delays in releasing compensation payments to states.
  •  According to a report by the Ministry of Finance, the GST compensation shortfall for the financial year 2020-21 was around ₹2.69 lakh crore. The central government allowed states to borrow up to ₹1.1 lakh crore to cover the gap.
• Federal Tensions: The delay in compensation payments and the uncertainty surrounding the future of the compensation scheme created tensions between the Centre and states. States expressed concerns about their fiscal health and accused the Centre of not fulfilling its obligations.

Conclusion

As India continues to recover from the pandemic, it is crucial to find sustainable solutions to the GST compensation challenges. By working together, the central government and the states can ensure a fair and equitable distribution of resources, strengthening federalism and promoting economic growth.

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