What Some States Plan To Do After GST Compensation Cess Period Ends

States are staring at a revenue shortfall once the goods and services tax compensation period ends this June. Some of them are banking on tax buoyancy and state tax hikes to make up for this shortage. But that may not be enough.

The compensation cess was introduced alongside the unified national tax to ensure states' GST revenue increased by 14% every year, for a promised period of five years. Levied as a cess on sin goods, compensation cess collections have underperformed for three years, due to slowing economic growth and then the pandemic. To make up for the shortfall of previous years the cess levy has been extended till March 2026, but the compensation period ends in June.

This year, once the compensation regime ends, the shortfall in revenue for states could be "massive" at around Rs 1 lakh crore, Tarun Bajaj, revenue secretary, said in his post-budget interaction with industry lobby CII.

According to Soumya Kanti Ghosh, chief economic advisor at SBI Research, GST compensation contributes more than 20% of the tax revenue for seven states. An end to this regime will accentuate financial stress, he told BloombergQuint.

The states include Assam (22%), Bihar (29%), Delhi (32%), Gujarat (20%), Himachal Pradesh (28%), Jharkhand (20%) and Karnataka (23%).

And even though state GST collections have improved in the last few months, that may not be enough for some of the producer states as GST is primarily a destination-based tax.

“Producer states will face more fiscal stress as consumption happens outside state lines," Sacchidananda Mukherjee, economist at National Institute for Public Finance and Policy, told BloombergQuint. "Punjab, Chhattisgarh, Jharkhand and Odisha might face the impact more as they are producer states involved in agriculture and manufacturing.”

As the end date approaches, state representatives have asked for an extension of the compensation period by another five years. Finance Minister Nirmala Sitharaman acknowledged in parliamentary replies that the issue came up in GST Council meeting and states have also written to the central government.

The centre has remained ambivalent about any extension, prompting states to start considering other ways to boost revenue.

Senior officials at the finance ministries of state governments spoke to BloombergQuint on the condition of anonymity to express their views candidly.

Southern states, including Karnataka and Kerala, are hopeful that a recent buoyancy in GST collections would help somewhat offset the loss of compensation cess.

Officials of Kerala are counting on improved collections and revenue flexibility from existing sources. Last year, the state collected Rs 1,000 crore a month from liquor taxes and its highest collection of Rs 4,000 crore from stamp duty and registration.

But, even that has reached a saturation point, said an official from Kerala.

An official at the Tamil Nadu Finance Ministry said states would resort to revenue augmentation measures within their control. Some state-controlled taxes include stamp duty, registration, liquor and fuel taxes and local property tax.

Tamil Nadu has approved an across-the-board revision of property tax to increase the income of urban local bodies. The tax hike ranges from 25-100% for homes with an area of 600-1,800 square feet, and goes up to 150% for area above 1800 sq. ft. in Chennai.

That alone could raise Chennai municipal corporation's revenue by Rs 600 crore this year, said the official cited above.

Tamil Nadu also increased the rates of tax, by Rs 10-80 per bottle, on Indian-made foreign liquor sold through Tasmac or Tamil Nadu State Marketing Corp. The move is likely to fetch over Rs 2,000 crore to the state, according to a report by the Hindu newspaper.

Maharashtra, too, has unveiled a 'Metro Cess', which would increase stamp duty charges on property registration in the state effective April. According to a report by the Times of India in March, the stamp duty in Mumbai will go up by 1-6% of the asset’s value and would be 7% in Pune, Nagpur, and Thane.

Jharkhand is mulling similar revenue collection measures. A significant portion of revenue for the state comes from minerals, led by coal. The dependence on coal is concerning as India looks to phase out the fossil fuel to meet its climate commitments, said an official from the state.

Odisha has not taken any decision yet but state officials BloombergQuint spoke with said they were confident of meeting the revenue challenge. Odisha's finance base is good and the state will take a decision after May when revenue collection numbers are published, an official said. It's a revenue surplus state and doesn't expect a big deficit, he said.

In addition to raising taxes, states may have to curtail expenditure on populist schemes.

Offering "freebies like farm loan waiver and restoring old pension system" puts them in an economically unsustainable situation in the long term given their fiscal position, said Ghosh.

Telangana tops the list at 35% of revenue receipts spent on such schemes. Rajasthan, Chhattisgarh, Andhra Pradesh, Bihar, Jharkhand, West Bengal, and Kerala have committed to spend 5-19% of their revenue on populist schemes, Ghosh said citing his findings in an SBI Research report.

"It's time for states to distinguish between freebies and entitlements to the poor that are necessary," said Ghosh.

The central government's Financial Assistance to States for Capital Investment scheme may provide a little breathing space. The outlay was enhanced to Rs 15,000 crore in the revised estimate for 2021-22 and was further increased to Rs 1 Lakh crore in 2022-23.

Provisions for additional borrowing, subject to completing power sector reforms, give states room for capex. The finance minister in her budget speech announced that states will be allowed to run a fiscal deficit of up to 4% of GSDP, of which 0.5% will be tied to power reforms.

States have been urging the central government to release pending compensation cess dues.

For fiscals 2020-22, GST compensation cess declined due to the pandemic. The centre refused to pay for the shortfall and offered instead to borrow Rs 1.1 lakh crore for FY21 and Rs 1.59 lakh crore for FY22 and release it to states as back-to-back loans.

In a status update note on Wednesday, the finance ministry said including the loan amount, Rs 2.78 lakh crore of compensation had been released to states for the year 2020-21, and "nothing was pending for the year".

The compensation requirement increased during 2020-21 owing to the pandemic impact on revenues.

"Currently, only for the year 2021-22, compensation of Rs 78,704 crore is pending due to inadequate balance in the fund, which is equivalent to compensation of four months," the statement said.

While GST compensation dues, capital assistance and loans may offer some relief, Kavita Rao, economist at the National Institute of Public Finance and Policy, said short-term solutions won't be enough.

"While measures to augment capex in the short term would help in current financial year, where would they (states) find resources to ensure reasonable growth in revenue in the medium term?"

She told BloombergQuint that GST Council will have to re-examine the GST rates and GST base while deciding on whether some current exemptions must be brought into the tax net.

The next meeting is expected in May. The council is likely to take up rate rationalisation and compensation.