“It is demeaning and embarrassing,” says Manpreet Singh Badal, the finance minister of Punjab. “We signed away our financial sovereignty but are now being denied the compensation promised to us.
We are staggering salaries and borrowing from state PSUs to clear the dues.”
Badal is referring to the issue of delay in the Centre paying states their goods and services tax (GST) compensation.
The landmark indirect tax regime, which came into force in July 2017, subsumed most central and state taxes.
States were guaranteed by law to be paid for any loss of revenue in the first five years of GST implementation. However, several states are now claiming that the Centre has not paid them since August.
States not ruled by the Bharatiya Janata Party (BJP) or its allies are leading the charge. Two out of every three states in India are ruled by BJP or its allies.
Another thing that is worrying states is that the 15th Finance Commission (FC) — the panel that defines the financial relations between the Centre and states — might slash the latters’ share of the taxes collected by the Centre. This again raises questions about states’ fiscal autonomy when they are responsible for most of the country’s public spending and are fiscally more prudent than the central government.
Legal Battle Ahead?
On November 20, Kerala, Punjab, Rajasthan, West Bengal and Delhi issued a joint statement urging the Centre to transfer their GST compensation payment for August-September, due in October.
The dues for October-November are due to be transferred in December. These states are owed between Rs 1,500 crore and Rs 4,400 crore for the August-September period. States claimed that GST comprised nearly 60% of their tax revenues.
It is not clear how much all the states are owed in GST compensation for August-September. The Centre gave states nearly Rs 45,750 crore between April and July, according to the ministry of finance.
Kerala, governed by the Left Democratic Front, has threatened to take the central government to the Supreme Court if it does not clear the dues immediately. The state’s Finance Minister Thomas Issac said the delays have created a “fiscal crisis” in Kerala, which is owed Rs 1,600 crore in GST compensation for August and September. “Contractors’ bills are in arrears, and agri and welfare payments have been put on hold.”
The delay has thrown the fiscal math of states into disarray. States depend on transfers from the Centre for nearly half of their revenues. Tax devolution from the Centre is responsible for over a quarter of their total receipts and grants for a fifth.
States do not have much room to borrow to tide over the crisis as their gross fiscal deficit cannot exceed 3% of their gross state domestic product, though there are stringent provisions to extend the limit to 3.5%, and they have to seek the approval of the Centre for borrowings.
BJP-ruled states have not spoken out on the issue.
Sudipto Mundle, a member of the 14th FC and advisor to the 15th FC, says, “Just because the Centre is the tax collecting agency, it is illegitimately using its clout in the matter.”
Dip in Collection
The Centre has said the delay was because of lower-than-expected GST collections and the compensation cess, which is used to make up for states’ loss in tax revenue for five years as a result of their switching to the GST system. States have been guaranteed an annual 14% growth in tax revenues till 2022. Union Finance Minister Nirmala Sitharaman has said the central government would honour its commitment to states. But she did not say when.
Sitharaman and Revenue Secretary Ajay Bhushan Pandey did not response to queries.
The finance ministries of Maharashtra, the state with the largest economy, and of Gujarat, the prime minister’s home state, also did not respond to queries.
The GST Council — the apex body that decides on all matters related to the indirect tax — is scheduled to meet on December 18, where decisions are expected to be taken on increasing tax rates on certain categories and bringing some exempted items within the ambit of GST. In September, state governments turned down a request from the 15th FC to consider a lower GST compensation rate. They have also asked for the five-year compensation period to be extended till 2025.
GST collections grew in single digits every month between May and August, over the corresponding periods of 2018, before falling in September and October. The numbers rose 6% in November, according to the ministry of finance.
GST cess collections have declined year-on-year every month between August and November.
These poor numbers come in the backdrop of a slowing economy. India’s gross domestic product grew at 4.5% in the July-September quarter, the slowest rate of expansion in over six years. The Reserve Bank of India has cut the country’s economic growth estimate for 2019-20 to 5%, from 6.1% in October.
While states’ finances are bound to be impacted by lower tax collections in the face of a flagging economy, the Centre’s failure to transfer the GST compensation on time could aggravate the stress on their exchequer. States have had to recalibrate their expenditure in the face of a potential Rs 61,000 crore revenue loss from the corporate tax rate cut announced by the Centre.
“Denying states the capacity to spend at a time of economic slowdown is the worst thing you can do,” says Jayati Ghosh, professor of economics at the Jawaharlal Nehru University.
According to the Reserve Bank of India, states are fiscally more responsible than the Centre, with their average gross fiscal deficit in 2019-20 expected to be 2.6%, compared with the central government’s 3.3%. States have also on the forefront in public spending.
For instance, in 2010-11, states spent Rs 1.7 lakh crore on capital expenditure, while the Centre spent Rs 1.6 lakh crore, according to rating agency CRISIL. But in 2019-20, they are expected to spend Rs 6.2 lakh crore and Rs 3.4 lakh crore, respectively. In short, states are now responsible for nearly twothirds of government capex in India.
This is one reason why states have been demanding a higher share of the Centre’s divisible tax pool. The 14th FC had in early 2015 increased states’ share of the pool from 32% to 42%. But M Govinda Rao, a member of the 14th FC and former member of the economic advisory council to the prime minister, says the actual increase was from 39% to 42%, given that the new devolution formula included grants given earlier by the erstwhile Planning Commission, among other changes. The 14th FC recommendations are applicable between fiscal years 2016 and 2021. While states are now eligible for a bigger chunk of the tax pie, the Centre expects them to pay more for centrally sponsored schemes, like the National Health Mission, than before.
Moreover, the Centre has been hiking cesses and surcharges, which it doesn’t share with states, to shore up its revenues.
These levies, which were 9.3% of gross tax revenues in 2014-15, are expected to become 15% in 2019-20, according to the RBI.
“This government has progressively centralised revenues,” says Ghosh. “It is in bad faith.”
Rao says the rise in these levies has nullified the increased allocation granted by the 14th FC. As a result, the percentage of the total revenues of the Centre transferred to states has remained unchanged. It was around 53% in 2018-19, according to a National Institute of Public Finance and Policy (NIPFP) study.
There are reports that the Centre has sought a reduction in states’ share of the central tax pool, at 42% now, in the 15th FC.
HK Amarnath, associate professor, NIPFP, says this will impact states’ autonomy, since states are free to spend that money where they see fit, unlike funding for centrally sponsored scheme which comes with conditions. In addition, states may find it hard to opt out of a centrally sponsored scheme because of the political risks, says Abhay Pethe, senior resident fellow, Mumbai School of Economics and Public Policy.
There are exceptions, though. Odisha, Telangana, West Bengal and Delhi, all ruled by opposition parties, have chosen their own initiatives over the Centre’s Ayushman Bharat health insurance scheme.
Less for States
The 15th FC, headed by former revenue secretary NK Singh, will submit its final report by October 2020. It has already submitted an interim report for 2020-2021.
The Centre has asked the 15th FC to factor in spends on defence and internal security before its tax resources are shared with states — which will reduce the amount going to the latter. Mundle says the commission can choose to ignore it. “For them, the central government is just one of 29 governments.”
Any reduction in states’ share of taxes in the 15th FC is bound to lead to a serious pushback from their governments. But there are some economists, like Pethe, who believe state governments “lack the political and bureaucratic maturity” to spend wisely, despite their improved performance on several fiscal indicators. “The Centre has a greater responsibility than states. It is not possible for states to have a vision for the next 10-15 years.”
Though there may be a divergence in opinions on who is a better spender, it is clear the fiscal relations between the Centre and states are getting more strained.
This does not bode well for an economy under pressure.