GS Question

The Goods and Services Tax (Compensation to States) Act of 2017 was introduced in India to compensate states for any revenue losses incurred due to the implementation of the Goods and Services Tax (GST) system. Under this act, the central government pledged to compensate states for any shortfall in their revenue growth below a certain benchmark.

The rationale behind this act was to provide financial assurance and stability to the states, as the implementation of GST resulted in a degree of uncertainty regarding revenue generation. With the introduction of GST, various indirect taxes levied by the central and state governments were subsumed under a single tax regime. This disrupted the pre-existing tax revenue collection mechanisms of states, leading to concerns about potential revenue shortfalls.

The Compensation to States Act addressed these concerns by ensuring that states would not face any financial hardship during the initial years of GST implementation. The act created a compensation fund by levying a cess on select goods and services that would be used to compensate the states for any revenue shortfalls for a period of five years, from July 2017 to July 2022.

However, the outbreak of COVID-19 in 2020 severely impacted the Indian economy, leading to a significant contraction in economic activities and a decline in GST collections. This resulted in a substantial reduction in the GST compensation fund, making it challenging for the central government to fulfill its commitment to compensate states for revenue shortfalls.

As the GST compensation fund dwindled, tensions arose between the central and state governments. Many states argued that the central government was obligated to provide full and timely compensation as per the terms of the act. On the other hand, the central government faced fiscal constraints due to reduced tax collections and sought alternative solutions to meet the compensation requirements.

These tensions highlighted the challenges of fiscal federalism in India, where the fiscal responsibilities and powers are shared between the central and state governments. The states demanded that the central government borrow from the market to meet the compensation requirements, which led to disagreements over the responsibility for borrowing and repayment.

The issue of GST compensation fund and the subsequent federal tensions were exacerbated by the economic repercussions of COVID-19. The pandemic led to a decline in economic output, reducing GST collections and straining the fiscal capacities of both central and state governments. This necessitated a reevaluation of the GST compensation mechanism and calls for greater coordination and collaboration between the central and state governments to address the fiscal challenges arising from COVID-19.