Grand Deal Can End GST Compensation Tussle: Centre To Pay If States Back Bank Privatisation Bills

It takes no genius to figure out that the goods and services tax (GST) compensation issue is political rather than merely an economic demand from cash-strapped states for fiscal help. This is why the battle lines are drawn between BJP-ruled states and some allied parties, and those totally opposed to it.

The Kerala Finance Minister, Thomas Isaac, has been breathing fire from his Covid-19 recuperation bed, threatening to demand a vote on the borrowing options offered by the Centre at the next GST Council meeting on 19 September.

Broadly speaking, the Centre has offered states two options for compensation. Both involve the states taking loans on favourable terms. One part – the compensation relating to the GST structure – involves borrowing about Rs 97,000 crore, and a larger part, Rs 138,000 crore, is to make up for the shortfall resulting from the Covid-19 lockdowns and economic crash.

Together, the two shortfalls add up to Rs 2.35 lakh crore out of the Rs 3 lakh crore overall shortfall expected in 2020-21. The balance Rs 65,000 crore is projected to be funded by GST cess collections.

Option one is for states to borrow Rs 97,000 crore – loans on which they will pay no interest on the principal, with the principal itself being amortised by extending the GST cess beyond June 2022. Option two allows the states to borrow the full Rs 2.35 lakh crore, but in this case, they have to bear the interest costs even though the principal will be repaid by extending the cess beyond 2022.

A good argument the states make is that compensation was promised without strings attached when they signed up for GST. To now force them to take loans to raise resources during a Covid-induced slowdown is unfair and amounts to a refusal to honour commitments.

The Centre’s counter to this is that the compensation agreed to in 2017 was to be covered through the cess. It cannot now be forced to borrow to finance the compensation amounts.

In any event, the cess – created through the GST (Compensation to States) Act 2017 – is owned by the states. It cannot be used to fund loans taken by the Centre, and hence states are the best placed to borrow against a cess fund extended beyond 2022.

The states’ arguments are stronger, for they are based on the moral one of a Centre not reneging on its commitments. The Centre’s counter is weak, for nothing stops it from amending the GST cess law to make the amounts collected payable to the central exchequer.

The problem is not insoluble, and if it comes to voting, the Centre will probably carry the day with the help of some states that back it on key laws.

Under the GST Council voting structure, every state has an equal vote, which means tiny Nagaland has the same vote as massive Uttar Pradesh. As things stand, the BJP controls 17 states, and four more are ruled by friendly opposition parties (Tamil Nadu, Odisha, Andhra Pradesh and Telangana).

The latter could be cajoled to back the Centre’s stand if it comes to a vote. It would take a solid block of 12 states to block the Centre, since 25 per cent is the blocking minority and each state currently has a bit more than 2 per cent of the vote.

The reason why the GST Council has functioned fairly smoothly so far is that most decisions have been taken by consensus, and not voting. If this changes now, when the council meets on 19 September to consider the GST compensation options, it would worsen the climate for cooperative federalism, something the country needs badly when it is fighting three C’s – Covid, China and (economic) contraction.

But, if we acknowledge that the real opposition is political, the Centre needs to make political moves to obtain a consensus, just as it did for the abolition of Article 370, the Triple Talaq Bill and the Citizenship Amendment Act.

The deal that the Centre can offer will benefit the economy substantially, and it should be something like this.

The Centre can offer to fully compensate states without any borrowing by the latter provided opposition-ruled states agree to amend laws that prevent privatisation of nationalised companies, including many banks.

The Centre would then use the proceeds from privatisation and land and asset sales to compensate states from its own immediate borrowings. The compensation cess and privatisation proceeds can be used to honour the Centre’s promises to states.

The Centre should offer this deal along with another sweetener: all future privatisation proceeds will be shared upto 20 per cent with the states in which those undertakings are located; in the case of entities (like banks) which exist in most states, the same 20 per cent can be equally shared based on some proportionate formula (number of branches in specific states, etc). States can also be promised a share of other asset sales, too, including land leased by states to central entities.

As things stand, bills to amend the bank nationalisation act and other laws that will enable privatisation of other central entities can be passed by the BJP in the Lok Sabha, but in the Rajya Sabha it would need substantial support from the opposition parties. The time to strike this political bargain is now, when all states are feeling the pain of Covid-19 and weak economic revival.

The states are actually not in that strong a position if the Centre decides to play hardball and asks them to go to court over the compensation issue.

There is no guarantee that the courts will not see an “act of god” or national security (Covid or China) as material enough factors for declaring non-payment of compensation as unimplementable this year.

Even if the court verdict goes against the Centre, the latter can threaten to refuse any further protection of revenues after 2022, which means most states will have to fend for themselves entirely.

If they sign up to the deal, the Centre can negotiate a lower level of revenue growth guarantees tied to actual GDP trends. That won’t be a bad bargain after June 2022.