Context:Centre-State relations have plumbed the depths because of the Goods and Services Tax (GST) compensation issues.

Background of Goods and Services Tax (GST) compensation issues 

  • The economic slowdown, which has been on for almost three years now, began to impact GST revenue collections in August 2019. 
  • As per the Centre’s estimates, the States’ GST revenue gap in 2020-21 will amount to about ₹3 lakh crore, while cess collections are only projected to reach ₹65,000 crore, leaving a shortfall of ₹2.35 lakh crore.
  • The center offered two options for borrowing by States to meet the shortfall.
  1. The first option assumes 10% revenue growth, which put the compensation requirement at Rs 97,000 crore, due to ‘implementation issues’. In this case, states will be allowed to borrow through a deal with the RBI, facilitated by the Centre.
    • This amount can be repaid after five years through the collection of cess. 
    • For States choosing the first option, the center would remove conditions around a further 0.5% relaxation in States’ borrowing limits under the FRBM Act.
    • Under the fiscal responsibility and budget management (FRBM) act, the states are mandated to keep their fiscal deficit under 3% of their respective gross state domestic product (GSDP).
  2. The second option is that the entire gap of ₹2.35 lakh crore can be met by the borrowing by the States by an  RBI arrangement.
    • The opinion of the Attorney General of India was cited to put forward the argument that GST compensation has to be paid for the transition period from July 2017 to June 2022, but the compensation gap cannot be bridged using the Consolidated Fund of India. 

States’ response to the center’s proposal:  

  • It was on the basis of GST (Compensation to States) Act, 2017 that States sacrificed their constitutionally granted powers of taxation in the national interest. The states were pressing that the Centre should borrow from the market.
  • Increase FRBM limits: The centre had relaxed the limit to 3.5% of GSDP for FY20, but states now want higher relaxation in the limit for FY21.

The Center ultimately decided to borrow the money itself.

Federalism under strain

  • A diversity of interests is the badge of federalism, and there will be constant negotiation and renegotiation. It is this tension that keeps a federation ticking.
    • But the GST compensation issue not only shook the foundations of the GST, with at least one State threatening to go to court over the issue, but also exposed the hollowness of claims about cooperative federalism.
  • Center dictating rules: 
    • The Centre, in view of the Covid-19 pandemic, had allowed additional borrowing limit of up to Rs 4.28 lakh crore (2% of GSDP) to states for FY21. 
    • While 0.5 percentage point (pp) of the extra borrowing window (Rs 1.07 lakh crore) is available to all states unconditionally, the balance 0.5 pp was to be accessed by states, subject to their ‘completely meeting’ reforms related to the one-nation, one-ration-card system and ease of doing business,
    • The Center bypassed the GST Council to prevent “unionised bargaining” by the States. 
  • States giving up authority
    • States no longer possess taxation rights after most taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under GST. 
    • The puzzle is why the States agreed to shrink their authority in determining Budget spending (Fiscal Responsibility and Budget Management Act )and setting tax rates (value-added tax, or VAT, first and GST now).
    • Economic and normative reasons include efficiency, equity, stabilisation, economic growth, and balanced development, among others. 
    • Political reasons: The greater the degree of party centralisation, the higher the possibility of federal centralisation. 
    • E.g. in the period of Congress dominance, the Congress used (and misused) every available means, including, the use of Article 356, the institution of the Governor and discretionary central grants among others to continue its dominance.
    • The coalition era inaugurated a seemingly more cordial period of Centre-State relations based on a recognition of mutual interests.
    • During this period, State-based parties called the shots that much of the authority migration began.
  • Authority migration towards the Centre: In a polity-wide disciplined party, acceding to the central government’s demands may secure the career prospects of State-level leaders. 
    • Similarly, for State-based parties, there is access to resources and the possibility of influencing national-level decisions through federal coalitions.
    • Party linkages between different levels of government are crucial to both the making and the maintenance of federal compacts.

The GST agreement also illustrates the complexity of political negotiations. From a period in which State-based parties had heft, we now have a one-party formation calling the shots. While the States are negotiating within the agreed framework, the Centre’s actions undermine the federal architecture.

Image source: Business Standard

After reading this article, answer the following question for Mains answer writing practice. Also you can get your answer checked free of cost by clicking on the following link.

For Mains:

Q) The States have shrunk their authority in determining Budget spending (Fiscal Responsibility and Budget Management Act ) and setting tax rates (GST).Critically analyse the reasons behind the shift in authority towards the Center. (250 words)