The states are preparing for a quarrel with the Union government over what they say is inadequate sales tax compensation provided for in the budget, putting at further risk the implementation of the goods and services tax (GST), one of the most sweeping reforms envisaged in recent years.

Union finance minister Pranab Mukherjee didnt make any major provision for central sales tax (CST) compensation in the budget for fiscal year 2013 (FY13) that he unveiled in Parliament on 16 March, heightening the sense of grievance among the states.

The Centre has only made a budgetary provision of Rs.300 crore towards CST compensation in the budget, said Sushil Kumar Modi, chairman of the empowered committee of state finance ministers. We had through a letter to finance minister Mukherjee informed the central government of our concerns. But the central government did not take that into account and make provision in the budget.

The committee is planning to meet in the second week of April to decide on the next move by the states after their own budgets are presented, said Modi, also deputy chief minister of Bihar. Lawmakers are also expected to raise the issue in Parliament in the coming days, he said.

States had cut CST to 2% from 4% as part of a gradual phase-out of the tax as part of facilitating the transition to GST, with the central government compensating states for the revenue forgone. The states had asked for a compensation of Rs.19,000 crore for 2010-11 and the Centre had provided Rs.12,000 crore in the FY12 budget. Of the total compensation for 2010-11, the Union government released only Rs.6,393 crore to 13 states.

The implementation of GST will mean the levy of a uniform rate of tax across the country, effectively turning it into a common market and getting rid of the inefficiencies and distortions caused by disparate levies and boosting economic growth.

With the GST launch getting indefinitely delayed, the Union government informed states that they will not be compensated from FY12 onwards and the payout for 2010-11 will be restricted to the amount that had already been given.

It has also not agreed to bring CST back to 4% as suggested by the states.

The states had hoped the Union government would reconsider their demands and make budgetary provisions for the compensation. The Centre, which hasnt been able to gather enough states support to provide a definite date for the start of GST, believes it has been more than fair.

Compensation was originally planned for three years. The government cannot keep paying endlessly for as many years as GST does not come, finance secretary R.S. Gujral said recently.

The Centres reluctance is likely to worsen its relations with the states and pose fresh hurdles in the implementation of GST, according to analysts and others involved in the process.

The Union governments attitude was described as thoughtless and an error of judgement by Yashwant Sinha, chairman of the parliamentary standing committee, which is currently examining the Constitution amendment Bill and has the challenging task of forging a consensus between the Centre and the states on various GST provisions. The Centre should have been particularly sensitive to states needs, he said in a recent interview.

The Centre, already weakened after defeats in recent state assembly elections, will be forced to deal with the states hostility.

The states had agreed to raise VAT (value-added tax) to 5% from 4% to make up for the loss in revenue from the phase-out of CST, said Prashant Deshpande, leader (indirect tax) at Deloitte in India. States have no easy way out now from this stand-off with the Centre since the budget has not made any proposal for the CST compensation. The only option is to exert political pressure on the government.

Pressure will also come from quarters that would be considered friendly. Its not only opposition-ruled states that will be affected. A Congress-ruled state like Maharashtra will be one of the most impacted states, he said. The Congress leads the ruling United Progressive Alliance coalition.

Another issue that has raised hackles is the budget announcement on taxing services based on a negative list, which has not taken into consideration some of the key concerns of states. Under the new regime, services on the list will not be taxed.

We had approved the negative list of services, but with some riders, Modi said. We had asked that items on which states are levying tax should not be included in the (list). But the Centres list has not taken that into consideration.