The prevailing economic condition owing to the Covid-19 pandemic has elicited demands from several states for the extension of the Goods and Services Tax (GST) compensation cess regime for another five years. This financial upheaval has also led to requests for an increase in the share of the Union government in centrally-sponsored schemes.
Background and Overview: GST Taxation
The GST compensation cess regime was instated on 1st July 2017, following the enactment of the 101st Constitution Amendment Act, 2016. It resulted in the merger of a large number of central and state indirect taxes into a single tax structure. The provision for GST compensation is set to conclude in June 2022.
Understanding the GST Compensation Concept
Revenue generation from GST was expected to be equatable to the previous taxation structure. However, GST is taxed on consumption, not manufacturing. As a result, no taxes are levied at the place of production, which adversely impacts manufacturing states. To mitigate this issue, a compensation scheme was introduced. Central government promised compensation to states facing any shortfall in tax revenue due to GST implementation for a period of five years. This reassured several initially hesitant states to agree to the new indirect tax regime.
Role and Functioning of Compensation Cess
Compensation cess guarantees states against any revenue shortfall below 14% growth (base year 2015-16) for the first five years ending 2022. The Centre remits GST compensation every two months to states from this fund. The GST (Compensation to States) Act of 2017 specified the framework for compensation cess. All taxpayers, barring those who export certain notified goods or those who have opted for the GST composition scheme, are required to collect and pay the GST compensation cess to the central government.
Composition of The Compensation Cess Fund
The GST Act stipulates that the cess collected, along with the amount recommended by the GST Council, would be credited to the fund.
Key State Concerns: Revenue Shortfall and Economic Slowdown
There has been a significant revenue shortfall due to the ongoing pandemic. It is projected that the state’s GST revenue gap might reach approximately Rs. 3 lakh crore in 2020-21, while cess collections are only likely to reach about Rs. 65,000 crore, thereby causing a shortfall of Rs. 2.35 lakh crore. Current economic conditions, coupled with delays in paying state compensation, have made it challenging for them to manage their financial requirements.
Declining Central Devolution
Most states feel that the Centre’s share in centrally-sponsored schemes has gradually diminished, leading to an increased burden on the states. As a result, there is a strong demand for a greater share in centrally-sponsored schemes.
Role and Impact of Goods and Services Tax
GST, introduced through the 101st Constitution Amendment Act, 2016, is regarded as one of the most significant indirect tax reforms in the country. It was structured around the ‘One Nation One Tax’ concept. The tax reform has absorbed indirect taxes like excise duty, Value Added Tax (VAT), service tax, luxury tax, and more. This system has effectively mitigated issues like double taxation, cascading effect of taxes, classification problems and has led to a common national market.
Tax Structure under GST
The GST tax structure is divided into three major segments. Central GST disciplines Excise duty, Service tax, etc., while State GST governs VAT, luxury tax, etc. Integrated GST (IGST) manages inter-state trade. IGST is not a tax per se but a system created to synchronize state and Union taxes. The overall tax structure under GST is divided into four slabs—5%, 12%, 18% and 28%.
