GST compensation period: States likely to push for five-year extension

States may discourage the Centre from reducing the outlay on Centrally Sponsored Schemes (CSS) and revenue deficit grants, even if it warrants borrowing from the markets. (Illustration: Ajay Mohanty)
States are likely to request the Centre for an extension in the goods and services tax (GST) compensation period, by up to five years beyond FY22. This is driven by the severe shortfall in revenue owing to disruption in economic activity.

The GST Council is expected to meet this month to discuss alternative compensation mechanisms, amid inadequate cess collections. States may write to the 15th Finance Commission, seeking the extension. They are likely to point out the challenge in meeting routine expenditure after 2022, in the absence of any compensation.

States may discourage the Centre from reducing the outlay on Centrally Sponsored Schemes (CSS) and revenue deficit grants, even if it warrants borrowing from the markets.

In addition, they may request for an increase in the unconditional borrowing limit. At present, a state can go for such borrowings till its fiscal deficit hits 3.5 per cent of the gross state domestic product (GSDP). States want the threshold to be raised to 4.5 per cent.

However, states are divided when it comes to market borrowings.

“We will write to the finance commission seeking extension of the compensation period by five years. There is no scope to hike rates this year as we can’t burden the common man,” said Sushil Kumar Modi, deputy chief minister of Bihar.

“Since states will not burden the Centre’s exchequer with compensation in case of inadequate collection, the finance commission should consider extending the compensation period. By the time we are able to hike tax rates, the compensation period will be over,” he added.

Further, he said that the Centre should not cut down on centrally sponsored schemes and revenue deficit grants. “We are not getting compensation, so the Centre should not further burden states by cutting CSS and revenue deficit grants,” said Modi.

Punjab will also press for extension beyond 2022. “If I cannot meet my expenses, what do I do? We need the highest compensation, given that a fourth of our revenues are based on food grains that got subsumed under GST. We went ahead with GST because it was in national interest,” said Punjab FM Manpreet Singh Badal.

West Bengal and Kerala will follow suit. The former is of view that the Council does not have any equity/security to offer for borrowing from the markets, hence the compensation period should be extended.

“The GST Council doesn’t have a locus standi, how can it borrow? It doesn’t have equity and no security to offer,” said West Bengal FM Amit Mitra. His Kerala counterpart Thomas Isaac also favours an extension.


Rajat Bose, partner at Shardul Amarchand Mangaldas and Co, said the government has limited options to raise funds for compensating states. These are raising cess, bringing more items within the ambit of cess, or borrowing more.

“The first two options seem a distant reality given the present situation. If the government resorts to the third option, then one way to offset the borrowing will be to extend the cess for at least a couple of years beyond 2022,” Bose added.    

If the compensation cess is extended beyond 2022, then cars, cigarettes, and aerated drinks will continue to be burdened with the cess beyond 28 per cent. 

States had earlier approached the finance commission to extend the compensation cess, but only by two years. The commission, on the other hand, had advised lowering the rate of revenue growth from 14 per cent to consider tax losses, which states rejected. 

They were assured full compensation for their revenue losses for the first five year of the GST regime. The losses here refer to states missing out on 14 per cent growth in tax revenues, on the base year of 2015-16.


A report by the commission also stated that states would need compensation under GST even after 2022.

Subsequently, states will ask the Centre to increase the unconditional borrowing limit, under the Fiscal Responsibility and Budget Management (FRBM) Act, to 4 per cent of GSDP, versus 3.5 per cent now.

Under its Atmanirbhar Bharat package, the Centre increased states’ fiscal deficit limit to 5 per cent from 3 per cent, but only up to 3.5 per cent was unconditional. Beyond that, there were riders such as the state’s performance in implementing ‘one nation one ration card’, ensuring ease of doing business, carrying out power reforms, and boosting urban local bodies’ revenues.

The Budget has projected allocation to CSS to rise to Rs 3.4 trillion in FY21, from Rs 3.2 trillion in FY20 (revised estimates). Various grants recommended by the finance commission, including the revenue deficit grant, are pegged at Rs 1.5 trillion, against Rs 1.2 trillion over this period.
As against Rs 95,000 crore in compensation during FY20, the Centre disbursed Rs 1.15 trillion to states up to November using the balance from previous years, and Rs 36,400 crore for the three months up to February from pending IGST dues from FY18.

Although cess collection improved significantly to Rs 7,665 crore in June from Rs 6,020 crore in May and Rs 990 crore in April, collection for Q1 was down 40 per cent year-on-year.

The Centre and states have managed to mop up just Rs 1.85 trillion from GST in Q1FY21, which was 41 per cent lower than the mop-up in the corresponding period last year.



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