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Finance commission may not extend GST compensation
May, 22nd 2019

The 15th Finance Commission is unlikely to heed the request of state governments to extend the period for the goods and services tax (GST) compensation beyond the initial five years, holding that tax buoyancy will take care of the current shortfall in revenue in some states.

“As GST is a consumption-based tax, the real problem with states is that the guaranteed compensation will end in two years from now, which covers two out of the five years of my award period beginning 2020-21. Some of the states are worried because they are not getting that degree of growth. The changes in GST have now more or less settled down. I now see growth on a more positive wicket. I don’t believe it is necessary nor would it be appropriate (to extend GST compensation). I expect the growth momentum to take care of it," said the chairman of the 15th Finance Commission, N.K. Singh.

Loss of revenue to the states on account of implementation of GST shall be payable during the transition period of five years till 2021-22, according to the provisions of the GST (Compensations to States) Act, 2017.

The financial year 2015-16 has been taken as the base year for calculating the compensation amount payable to states and the projected nominal growth rate of revenue subsumed for a state during the transition period is assumed to be 14% per annum. The total compensation payable in any financial year is the difference between the projected revenue for any financial year and the actual revenue collected by the state.

The 15th Finance Commission is unlikely to heed the request of state governments to extend the period for the goods and services tax (GST) compensation beyond the initial five years, holding that tax buoyancy will take care of the current shortfall in revenue in some states.

“As GST is a consumption-based tax, the real problem with states is that the guaranteed compensation will end in two years from now, which covers two out of the five years of my award period beginning 2020-21. Some of the states are worried because they are not getting that degree of growth. The changes in GST have now more or less settled down. I now see growth on a more positive wicket. I don’t believe it is necessary nor would it be appropriate (to extend GST compensation). I expect the growth momentum to take care of it," said the chairman of the 15th Finance Commission, N.K. Singh.

Loss of revenue to the states on account of implementation of GST shall be payable during the transition period of five years till 2021-22, according to the provisions of the GST (Compensations to States) Act, 2017.

The financial year 2015-16 has been taken as the base year for calculating the compensation amount payable to states and the projected nominal growth rate of revenue subsumed for a state during the transition period is assumed to be 14% per annum. The total compensation payable in any financial year is the difference between the projected revenue for any financial year and the actual revenue collected by the state.

One of the major reasons for the huge shortfall of revenue for states compared with the national average is the inbuilt structural design of GST, in which the taxes are levied on destination-based principle, according to a study conducted by the GST Council in September 2018. The study had focused on the large gap between the revenues of states and Union Territories such as Punjab, Himachal Pradesh, Uttarakhand, Jammu & Kashmir, Puducherry and Bihar, and the national average.

For states suffering a huge revenue gap, there was substantial contribution to the states’ exchequer from the subsumed taxes such as central sales tax and purchase tax before the implementation of GST.

“Some other reasons for revenue shortfall are natural and structural factors, such as geographical location, size of the economy, endowments of natural resources, smaller taxable base, consumption pattern, and differential tax rates under the value added tax regime," the report said.

The more important problem is that some states believe GST is in a sense a real subjugation of their fiscal autonomy, Singh said. “Because, earlier, the Finance Commission going to any state would say ‘why don’t you raise your excise revenue’. Now states say, ‘now tell us what to do’. The answer to this is that all states have (willingly) agreed to implement GST," he added.

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