In today's Finshots we discuss what is shaping up to be the most important GST council meeting yet

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The Story

This is going to be a pretty big week for the Goods and Services Tax (GST) regime.

Why’s that, you ask? Well, the GST council is meeting as we speak. And the council includes representatives from state and central governments. Here, they will be discussing a rather contentious topic — GST compensation!

If you’re not familiar with this idea, don’t fret, we will take it from the top. A few years ago, the government mooted the idea of a simplified tax regime for the country, GST — “One Nation, One Tax.” And to achieve this gargantuan feat, they had to scrap multiple different taxes levied by state governments and introduce a uniform tax slab across the country. The idea had a lot of intuitive appeal. However, implementing it on a nationwide scale was always going to be challenging.

And the primary opposition came from states. As we wrote earlier:

It (GST) was a consumption-based tax. Meaning states with higher consumption figures were ideally expected to benefit more than producer states. For instance, Karnataka would collect taxes on biscuits consumed in its state, even if the biscuits were manufactured in Tamil Nadu. And this bit was deeply problematic because states like Tamil Nadu made massive investments on roads, highways and ports in a bid to incentivize manufacturing. Until the introduction of GST, they were entitled to extract a return on their investment by claiming taxes at the point of origin i.e. where the goods were manufactured. But with GST, they were in a bind because this tax revenue was now being apportioned to the consumer states.

So the central government had to strike a compromise. They had to offer states like Tamil Nadu some form of compensation — to make it more palatable.

And here's what they did. They promised to create a projection for five years and tally it with actual GST revenues. For instance, each year a state’s tax revenue was expected to grow by 14% (from the base 2015–16) and then, if actual collection fell short of these projections, the centre promised to make up the shortfall. To this end, the centre created a GST compensation fund and began extracting a cess (a tax over and above GST) from the sale of certain products including tobacco. They hoped to pay states using money from this fund.

For states struggling to shore up revenue, this idea made a lot of sense. And so they agreed to take the deal so long as the compensation scheme stayed on for at least 5 years. And the arrangement worked for the most part.

But now, that promise is finally coming to an end — in June 2022. This very month!

However, you must ask a very pertinent question at this point. This compensation fund was only expected to stay for 5 years. Everybody knew this. It’s not an unforeseen event. So why are states upset right now?

Well.. here's the thing. As we mentioned earlier, the central government mobilized resources for the compensation fund by placing an additional tax (a cess) on items like tobacco, cars and aerated beverages. Technically, that should have gone once the compensation agreement concluded. But it’s not going away.

Instead, over the weekend, the government confirmed that the cess will stay till March 2026. Another 4 years!

But …this time the proceeds won’t be going to the states anymore!

Instead, the central government will keep it.

Yeah, the government had a tough couple of years dealing with the pandemic. They spent a lot of money while not earning as much. In the end, they were forced to borrow ₹1.1 lakh crores in 2020–21 and ₹1.59 lakh crores in 2021–22.

And now they’re hoping that the cess could be used to pay back the loans.

Needless to say, state governments are fuming at this news. The pandemic affected them too and they want proceeds from the cess.

To this end, they might have some ammunition — to argue their case.

See, when the SC was hearing a matter related to GST on ocean freight, things took a wild turn. The SC went ahead and made a statement* saying that the decisions made by the GST Council aren’t binding. It said that they are merely recommendations and even states had the right to make tax decisions.

So, what could that mean for the future of GST?

Well, if we take the words of T.S. Singh Deo, the finance chief of Chhattisgarh, the GST regime could be facing some headwinds.

“This is not an ego tussle between the center and states. The idea is to ensure increase in revenue and if it doesn’t happen through the council then it will have to be from other avenues. This was supposed to be ‘one nation one tax’ and not ‘one nation one budget.’”

What he’s actually saying is this — if the states aren’t happy with discussions when they meet this week, they might as well choose to set aside the GST regime and raise revenue by imposing other taxes. And while it does sound a bit far-fetched, state governments are in fact talking about it publicly.

This is particularly worrisome considering the trust deficit that exists right now.

Back in 2020, the finance minister argued against compensating the states fully stating that the pandemic was an “act of god.” And although they were forced to concede ground eventually, the whole episode didn’t go down well with states at all.

And with the RBI already flagging concerns about the deteriorating financial situation in places like Bihar, Kerala, Punjab, Rajasthan, and West Bengal, this meeting will be extremely important.

Will the centre manage to pull a rabbit out of the hat once again and strike a compromise?

We will know soon.

Until then…

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*The truth is that the SC statement actually doesn’t change anything. Earlier, too, the GST Council was a body consisting of representatives from the states and centre and decisions were made after discussions. It’s just that the recent stamp by the Supreme Court might have given states an upper hand in future negotiations.