The government plans to create a backstop facility for states to receive GST compensation for three additional years after the expiry of the first five years as mandated by the Constitution

The Union government plans to create a backstop facility for states to receive compensation for three additional years to implement the nationwide goods and services tax (GST) after the expiry of the first five years as mandated by the Constitution. This is aimed at ensuring that states grappling with a revenue shortfall after the implementation of the GST regime do not face a sudden fiscal shock when the five-year transition period ends in 2022.

The backstop facility would help continue compensation through an annual transfer of the centre’s tax revenue to the states, for which the 15th Finance Commission would prepare a blueprint, two officials said. The recommendation will help states get the GST compensation till 2025, when this finance commission’s term ends.

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Assured compensation helps in decision-making by consensus within the apex indirect tax decision-making body, the GST Council, where neither the centre nor the states can get decisions passed without the support of the other, according to the Union government. So far, all decisions—including GST rate cuts—have been taken by consensus, as states are confident of a 14% annual revenue growth, supported by the GST compensation.

The GST revenue trends of states would be a key parameter in finalizing the commission’s formula for devolution of central government’s tax revenues to states, Ramesh Chand, a part-time member of the finance commission and also a member of policy think tank NITI Aayog, said in an interview.

“We will see what kind of revenue deficit states will have after 2022 and how that can be met. It will be factored in the devolution formula,” he said. “We are having regular presentations on GST. “Also, when we visit states, they give us data, including that on GST revenue trends. This aspect will be factored into the commission’s recommendations.”

GST compensation to states for their revenue loss under the new indirect tax regime has aided in smooth decision-making in the council, said a GST Council official on condition of anonymity.

“Constitutional guarantee for compensation of GST revenue losses for the first five years has given states the confidence that the central government does not take their needs for granted. This, along with the finance commission grant, will take care of states’ revenue requirements,” said the official.

State governments, which have revenue slippage after the 2017 indirect tax reform that subsumed various taxes and cesses into GST, are pitching for a longer period of compensation.

One of them is Punjab, considered the granary of India. It had let its 3% cess on farm produce, a key revenue source for the state, to be subsumed into GST. Punjab received the second-highest GST compensation in FY18 at more than ?4,600 crore after Karnataka, which received over ?7,500 crore. Punjab finance minister Manpreet Singh Badal said in an interview that the state would take up the matter strongly with the finance commission.

“The finance commission is yet to visit Punjab. When they do, we will flag this issue. It (subsuming the taxes on farm produce) was yet another sacrifice Punjab made for the overall good of the country,” said Badal.

With the implementation of GST, states no longer have the full flexibility to raise additional taxes to meet any spurt in their revenue needs without the consent of the GST Council and are, therefore, dependent on the centre to a great extent, said R. Muralidharan, senior director at Deloitte India.