GST Council Meet: Himachal Pradesh Seeks Full Compensation
At the recent GST Council meeting, Himachal Pradesh formally requested full compensation for the revenue shortfall it has faced since the implementation of the Goods and Services Tax (GST). The state government argued that without this full compensation, its fiscal stability would be severely compromised, hindering its ability to fund essential public services and development projects. This article explains the context, the specifics of the state’s demand, and the broader implications for GST compensation in India.
Background: The GST Compensation Mechanism
The Goods and Services Tax (GST), implemented on July 1, 2017, was a landmark indirect tax reform in India. It replaced a complex web of central and state taxes with a unified tax structure. To secure the consent of states, the Constitution (One Hundred and First Amendment) Act, 2016 provided for compensation to states for any revenue loss arising from the transition. The GST (Compensation to States) Act, 2017, operationalized this provision, guaranteeing states a 14% compound growth rate in their tax revenue over the base year of 2015-16 for a period of five years (from 2017-18 to 2021-22). The compensation was to be funded by a cess levied on certain luxury and demerit goods, such as automobiles, tobacco, and aerated drinks.
Himachal Pradesh’s Specific Demand
Himachal Pradesh, a special category state, has consistently argued that the current compensation formula does not adequately account for its unique fiscal challenges. The state has a narrow tax base due to its hilly terrain and limited industrialization. Its revenue largely depends on tourism, hydroelectric power, and agriculture, all of which are vulnerable to external shocks. At the GST Council meeting, the state’s representative reiterated that the compensation provided under the existing mechanism is insufficient, and a full and immediate settlement of pending dues is necessary for maintaining fiscal stability. The state has also raised concerns about the impact of the COVID-19 pandemic, which severely affected tourism and local businesses, further straining its finances.
How GST Compensation Works
The compensation mechanism is designed to bridge the gap between the projected revenue (with 14% growth) and the actual revenue collected under GST. The calculation involves several steps:
- Base Year Revenue: The state’s tax revenue in 2015-16 (from taxes subsumed into GST) is taken as the base.
- Projected Revenue: The base year revenue is increased by 14% per annum to arrive at the projected revenue for each year of the compensation period.
- Actual GST Revenue: The actual revenue collected by the state from GST (including state GST and a share of central GST) is calculated.
- Shortfall: The difference between the projected revenue and the actual revenue is the shortfall that is eligible for compensation.
For example, if a state’s base year revenue was ₹10,000 crore, the projected revenue for the first year would be ₹11,400 crore (10,000 * 1.14). If the state actually collected ₹10,500 crore, the shortfall would be ₹900 crore, which the central government would compensate using the cess fund.
Common Problems and Criticisms
The GST compensation mechanism has faced several issues since its inception. A major problem is the shortfall in the cess collection itself. The revenue from cess has often been lower than the total compensation due to states, leading to delays in disbursal. To address this, the central government borrowed funds in 2020-21 and 2021-22 to meet the shortfall, with the borrowing repaid from future cess collections. Another criticism is that the 14% growth rate is not aligned with actual economic growth, penalizing states that experience slower growth. States like Himachal Pradesh argue that the formula does not consider the higher cost of providing services in hilly regions or the loss of revenue from specific local taxes that were subsumed.
Comparisons with Other States
Himachal Pradesh is not alone in its demand. Several other states, including Kerala, Punjab, and West Bengal, have also voiced concerns about the adequacy of compensation. However, the nature of the demand varies. For instance, Kerala has emphasized the need for a higher growth rate, while Punjab has highlighted the issue of declining tax collections. Himachal Pradesh’s situation is unique because of its special category status, which entitles it to more favorable treatment in central assistance. The state’s reliance on central transfers is higher than most other states, making any shortfall in GST compensation more impactful on its fiscal health.
Costs and Fiscal Implications
The immediate cost of not providing full compensation is a widening fiscal deficit for Himachal Pradesh. The state would have to either cut spending on essential services like health and education or increase its borrowing, leading to higher debt servicing costs. In the long term, this could affect the state’s credit rating and its ability to finance infrastructure projects. For the central government, acceding to the demand could set a precedent, leading to similar requests from other states, which would increase the fiscal burden on the union. However, the central government has maintained that compensation is payable only as per the existing legal framework, and any extension or modification requires a decision by the GST Council.
Alternatives and the Way Forward
Several alternatives have been proposed to address the issue of GST compensation beyond the initial five-year period. One option is to extend the compensation period for a few more years, as suggested by some states. Another is to revise the growth rate to a more realistic level, such as the nominal GDP growth rate. A third option is to increase the cess rates or broaden its base to generate more revenue. Some experts have also suggested that the central government should provide direct grants to special category states like Himachal Pradesh, separate from the GST compensation mechanism, to address their specific needs. The GST Council, which includes representatives from both the centre and the states, is the forum where these options are discussed and negotiated.
Frequently Asked Questions
Why is Himachal Pradesh demanding full compensation?
Himachal Pradesh argues that the current compensation is insufficient because its tax base is narrow and its revenue is highly dependent on sectors like tourism and hydroelectric power, which are prone to volatility. The state believes that without full compensation, its fiscal stability is at risk, which would hamper its development.
How is the compensation amount calculated?
The compensation is calculated as the difference between the projected revenue (base year revenue grown at 14% per annum) and the actual GST revenue collected by the state. The base year is 2015-16, and the projection is made for each year of the compensation period (2017-18 to 2021-22).
What happens if the cess fund is insufficient?
When the cess collected is less than the total compensation due, the central government has borrowed funds to bridge the gap, with the loans to be repaid from future cess collections. This happened in 2020-21 and 2021-22.
Is the compensation period over?
The original compensation period ended on June 30, 2022. However, the central government has extended the levy of cess until March 2026 to repay the loans taken to meet the shortfall. States have been demanding an extension of the compensation period itself, but no decision has been made yet.
What is a special category state?
Special category states are those that receive a higher share of central assistance due to their hilly terrain, strategic location, or other socio-economic disadvantages. They include states like Himachal Pradesh, Uttarakhand, and the northeastern states. This status gives them a 90:10 ratio for central funding in centrally sponsored schemes, compared to 60:40 for other states.
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