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Context: In a sharp retraction of its earlier position, the Finance Ministry said the Centre would borrow from the market to pay the GST compensation shortfall of Rs 1.1 lakh crore to states, and then act as an intermediary to arrange back-to-back loans to state governments.

More on news:

  • The move may break the impasse between the Centre and States over the issue of borrowings to recompense the latter, despite three meetings of the GST Council. 
  • It will offer a big breather to States, particularly those that have high fiscal deficits and would have had to pay higher rates if they approached the market.  

Special loan window

  • Under the Special Window, the estimated shortfall of ₹1.1 lakh cr (assuming all States join) will be borrowed by the Government of India in appropriate tranches. 
  • The amount so borrowed will be passed on to the States as a back-to-back loan in lieu of GST Compensation Cess releases.
  • The amounts will be reflected as the capital receipts of the State Governments and as part of the financing of its respective fiscal deficits
  • This will avoid the prospect of individual States having to pay differential interest rates if they borrowed this corpus as a State development loan.   
  • The country’s general government debt, which includes both the Centre’s and States’ borrowings will not increase due to this step.
  • The States that get the benefit from the Special Window are likely to borrow a considerably lesser amount from the additional borrowing facility of 2% of GSDP (from 3% to 5%) under the Atma Nirbhar Package. 

State Development Loans (SDLs) 

  • SDLs are dated securities issued by states for meeting their market borrowing needs.
  • The SDL securities issued by states are credible collateral for meeting the SLR requirements of banks as well as for availing liquidity under the RBI’s LAF including the repo.
  • The higher the fiscal strength of a state, the lower will be the interest rate (yield) it pays for the SDL borrowings.

Background of the issue

  • 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 Centre acknowledged that States are likely to face this huge GST revenue shortfall as the economy may contract due to COVID-19, which is termed as an unforeseen “act of God”.
  • The center has 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. 
    • The AG has suggested the compensation cess levy can be extended beyond five years to meet the shortfall.

States’ response to the center’s proposal:  

  • The constitutional framework of the GST does not provide an escape clause for ‘Acts of God’. 
  • It was on the basis of the GST (Compensation to States) Act, 2017 that States sacrificed their constitutionally granted powers of taxation in the national interest. 
    • In the previous GST Council meetings, the Centre assured payment of compensation for a specified period, if there were such a loss.
  • The states were pressing that the Centre should borrow from the market.
  • Increase FRBM limits: The center had relaxed the limit to 3.5% of GSDP for FY20 but states now want higher relaxation in the limit for FY21.
  • As per the GST (Compensation to States) Act, 2017, states are guaranteed compensation for revenue loss on account of implementation of GST for a transition period of five years (2017-2022). 
    • The compensation is calculated based on the difference between the current states’ GST revenue and the protected revenue after estimating an annualized 14% growth rate from the base year of 2015-16.
    • Any shortfall has to be compensated from the receipts of Compensation Cess imposed on selected commodities that attract a GST of 28 percent.
    • At present, the cess levied on sin and luxury goods such as tobacco and automobiles flow into the compensation fund. 
  • Significance of GST for states

    • States no longer possess taxation rights after most taxes, barring those on petroleum, alcohol, and stamp duty, were subsumed under GST. 
    • GST accounts for almost 42% of states’ own tax revenues, and tax revenues account for around 60% of states’ total revenues.


  • Falling states’ economy: Finances of over a dozen states are under severe strain, resulting in delays in salary payments and sharp cuts in capital expenditure outlays amid the pandemic-induced lockdowns and the need to spend on healthcare.
  • Fiscal federalism: 
    • Lesser tax sharing: The Fourteenth Finance Commission allotted 42% of central government tax revenues to States. However, Accountability Initiative’s analysis of State Budgets shows that States received only 30% of central tax collections during the 2015-19 period.
      • This has compounded the problem as the states’ own tax revenues are suffering due to the economic slowdown.
    • Cess funds not shared: The Centre raised an estimated ₹3,69,111 crore revenue through cesses and surcharges in 2019-20 alone. These are not shareable with States.
      • Similarly, cesses on petroleum products have resulted in the Centre receiving 60% of petroleum tax revenues, with only 40% going to States. In 2013-14, the ratio was 50-50.
    • Meddling with state list: Using cesses on agriculture [Krishi Kalyan cess] and sanitation [Swachh Bharat cess], the Union is entering domains that are a part of the state list.
    • Implementation of GST: States don’t have any autonomy on GST rates and, therefore, their taxation authority has squeezed further. 
    • Excess compensation fund absorbed by the center: When the GST compensation cess exceeded the amount that had to be paid to States, the Central government absorbed the surplus. 
  • The high rate of 14%, which has compounded since 2015-16, has been seen as delinked from economic realities. There is a proposal of a revenue growth rate of 10.6% (the average all-India growth rate in the three years preceding 2015-16). 

Monetary measures are the monopoly of the central government. Even borrowing is more efficient and less expensive if it is undertaken by the Central government. As equal representatives of the citizens of the federal republic of India, State governments deserve relief through the Consolidated Fund of India.

Goods & Services Tax Council 

  • It is a constitutional body under Article 279A for making recommendations to the Union and State Government on issues related to Goods and Service Tax. 
  • It was introduced by the Constitution (One Hundred and First Amendment) Act, 2016.
  • The GST Council is chaired by the Union Finance Minister and other members are the Union State Minister of Revenue or Finance and Ministers in-charge of Finance or Taxation of all the States.
  • Every decision of the Goods and Services Tax Council shall be taken at a meeting, by a majority of not less than three-fourths of the weighted votes of the members present and voting, in accordance with the following principles, namely: —
    • the vote of the Central Government shall have a weightage of one third of the total votes cast, and
    • the votes of all the State Governments taken together shall have a weightage of two-thirds of the total votes cast, in that meeting.
  • The GST Council is a symbol of cooperative federalism.

Consolidated Fund of India 

  • It is the most important of all government accounts. 
  • This fund was constituted under Article 266 (1) of the Constitution of India. 
  • All revenues received by the government by way of direct taxes and indirect taxes, money borrowed and receipts from loans given by the government flow into the Consolidated Fund of India.
  • All government expenditure is made from this fund, except exceptional items which are met from the Contingency Fund or the Public Account. Importantly, no money can be withdrawn from this fund without the Parliament’s approval.

Image source: The Financial Express