Subject: Economy

The introduction of the Goods and Services Tax (Compensation to States) Act, 2017 represents a landmark legislation ensuring fiscal protection to states during the transition to the new indirect tax regime. The COVID-19 pandemic has significantly tested this framework, creating unprecedented challenges in federal fiscal relations.

Rationale Behind GST Compensation Act

• Constitutional Guarantee: The Act provides legal backing to the Centre's commitment under Article 279A to compensate states for revenue losses arising from GST implementation.

• Revenue Protection: Ensures states receive compensation for any shortfall below 14% annual growth in GST revenues, calculated from the base year 2015-16.

• Compensation Mechanism: Funded through GST Compensation Cess levied on specific luxury and sin goods like tobacco, aerated drinks, and high-end vehicles.

Impact of COVID-19 on GST Compensation

• Revenue Shortfall: The pandemic caused severe disruption with GST collections falling by 80-90% during the initial lockdown period in April 2020.

• Compensation Fund Deficit: Reduced economic activity led to lower cess collections, creating a significant gap between states' compensation requirements and available funds.

• Extension of Cess: The compensation cess period was extended from 2022 to March 2026 to meet pending obligations and address pandemic-induced shortfalls.

Federal Tensions and Challenges

• Centre-State Discord: Disagreements emerged over the modalities of compensation payment, with some states rejecting the Centre's borrowing proposals.

• Fiscal Autonomy: States expressed concerns about their fiscal sovereignty and ability to meet developmental expenditure amid delayed compensation.

• Trust Deficit: The compensation shortfall created tensions in federal relations, with some states threatening legal action against the Centre.

The GST compensation mechanism, while designed to protect state revenues, faced unprecedented stress during the pandemic. Moving forward, there's a need to strengthen the federal fiscal framework through measures like revenue insurance mechanisms and robust dispute resolution systems to handle future economic shocks. The experience calls for reimagining cooperative federalism in India's fiscal architecture.