February 3, 2023

Lukmaan IAS

A Blog for IAS Examination



THE CONTEXT: In this article, we’ll discuss the issue of GST compensation cess and why after three years of the transition to the goods and services tax (GST), there is a strong case to strengthen the GST Council for the constitutional body to take informed decisions to reform the tax structure, rates and broaden the tax base.

THE BODY: A policy paper by the Pune International Centre, The GST Compensation Cess: Problems & Solution, by V Bhaskar and Vijay Kelkar recommends the creation of an independent GST Council Secretariat to offer professional advice on tax matters.

It also essentially calls upon the Centre to borrow more to deliver on its promise to compensate the states for five years from 2017-18 for any shortfall in GST collections in relation to the past trend, notwithstanding the fiscal pressures faced by it due to the corona pandemic. Both suggestions make eminent sense.

What is a GST Council?

  • Goods & Services Tax Council is a constitutional body for making recommendations to the Union and State Government on issues related to Goods and Service Tax.
  • Article 279A says that President shall by order constitute a Council to be called the Goods and Services Tax Council.

Composition of GST Council:

GST Council which will be a joint forum of the Centre and the States, shall consist of the following members: –

  • The Union Finance Minister – Chairperson;
  • The Union Minister of State in charge of Revenue or Finance – Member;
  • The minister in charge of finance or taxation or any other minister nominated by each state government – members.
  • One-half of the total number of members of GSTC form quorum in meetings of GSTC.
  • Decision in GSTC are taken by a majority of not less than three-fourth of weighted votes cast.
  • The council is devised in such a way that the centre will have 1/3rd voting power and the states have 2/3rd.


To establish highest standards of co-operative federalism in the functioning of GST Council, which is the first constitutional federal body vested with powers to take all major decision relating to GST.


Evolving by a process of wider consultation, a Goods and Services Tax structure, which is information technology driven and user friendly.

Mandate of GST Council:

  • The Goods and Services Tax Council shall make recommendations to the Union and the States on.
  • The taxes, cesses and surcharges levied by the Union, the States and the local bodies which may be subsumed in the goods and services tax.
  • The goods and services that may be subjected to, or exempted from the goods and services tax.
  • Model Goods and Services Tax Laws, principles of levy, apportionment of Goods and Services Tax levied on supplies in the course of inter-State trade or commerce under article 269A and the principles that govern the place of supply.
  • The threshold limit of turnover below which goods and services may be exempted from goods and services tax.
  • The rates including floor rates with bands of goods and services tax.
  • Any special rate or rates for a specified period, to raise additional resources during any natural calamity or disaster.
  • Special provision with respect to the States of Arunachal Pradesh, Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim, Tripura, Himachal Pradesh and Uttarakhand; and any other matter relating to the goods and services tax, as the Council may decide.
  • The Goods and Services Tax Council shall recommend the date on which the goods and services tax be levied on petroleum crude, high speed diesel, motor spirit (commonly known as petrol), natural gas and aviation turbine fuel.

What is the purpose of GST act?

  • As per the GST Act, states are guaranteed compensation for any revenue shortfall below 14% growth for the first 5 years ending 2022.
  • The compensation is calculated keeping the base year as 2015-16.
  • GST compensation is paid every 2 months by the Centre to states.

Compensation cess fund

  • A compensation cess fund was created from which States would be paid for any shortfall.
  • An additional cess would be imposed on certain items and this cess would be used to pay compensation.
  • The Act states that the cess collected and “such other amounts as may be recommended by the [GST] Council” would be credited to the fund.
  • In the first two years of this scheme, the cess collected exceeded the shortfall of States.
  • In the third year, 2019-20, the fund fell significantly short of the requirement.

The problem and its source

  •  A key source of the problem is that the 2017 Act guaranteed a tax growth rate of 14%, which is unachievable this year.
  • The 14% target was too ambitious to start with.
  • Given the government’s inflation target at 4%, this implied a real GDP growth plus tax buoyancy of 9%.
  • But the Central government is constitutionally bound to compensate States for loss of revenue for five years.

What are the issues related to compensation?

  • The impact of the pandemic on the revenue receipts of the Central and state governments has been devastating.
  • The total average collection of GST revenue in April and May is only Rs 94,323 crore, just 46 per cent of the previous year’s average bimonthly receipts.
  • The states have been guaranteed 14 per cent annual growth in GST revenue over 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 per cent .
  • The Compensation Cess Fund had already been under severe stress as the GST revenues have been far from buoyant.
  • The increase in revenue in 2019-20 has been a meagre 3.8 per cent compared to the previous year. The result is that even after paying Rs 1.2 lakh crore as compensation, the payments were three months in arrears at the end of the financial year.
  • And now with the pandemic, the fund requirement for compensation has dramatically increased. The payments are in arrears by more than Rs 1 lakh crore already.
  • If fund requirements have been ballooning on the one hand, fund availability has been shrinking on the other. This raises a fundamental question: How can the gap between fund availability and fund requirement be bridged?

Possible solutions

Revise the compensation formula

  • It was after much deliberation that the 14 per cent growth was guaranteed to the states. But the optimistic mood regarding the buoyancy of GST prevailing then has not been borne out by the actual outcome even after three years.
  • The implementation has been lacklustre, with the IT backbone yet to be completed and tax administration handicapped by too many impediments.
  • Further, the pre-election sharp reductions in tax rates without serious examination of the revenue implications have also contributed to the fall in revenue. The current rates are not revenue neutral.
  • It is in this context that the 15th Finance Commission Chairman formally proposed in the GST Council that it should revisit the formula.
  • The Council refused to even consider the proposal and was unanimous in rejecting it. The response would not be different even now.

Increase the Compensation Cess rate or bring additional commodities in its net

  • However, there is very little chance for any proposal to increase tax rates to be approved during the pandemic slump period.
  • Even the proposal for resolving the inverted duty structure of cloth, footwear and fertiliser, which is creating serious problems for the manufacturing sector, was rejected by the Council because it involved an upward shift of the final products to a higher tax bracket.

GST Council or the Compensation Fund must be empowered to borrow funds from the market

  • The period of the Compensation Cess can be extended for a year or an additional period long enough for repayment of the funds borrowed.
  • The advantage of the this option is that it would not affect the Centre’s finances.
  • Since the loans are not taken by the Centre, it has no fiscal deficit implications. And the liabilities would be liquidated automatically from the collection of the Cess during the extended period.

Constitution could be amended

  • The Constitution could be amended to reduce the period of guarantee to three years thus ending June 2020.
  • But most States would be reluctant to agree to this proposal.
  • It could also be seen as going back on the promise made to States.

Centre could fund shortfalls

  • The Central government could fund this shortfall from its own revenue.
  • The Centre’s finances are stretched due to shortfall in its own tax collection combined with extra expenditure to manage the health and economic crisis.

Agree that 14% growth target is unrealistic

  • The Centre could convince States that the 14% growth target was always unrealistic.
  • If the Centre can negotiate with States through the GST Council to reset the assured tax level, it could then bring in a Bill in Parliament to amend the 2017 Act.

WAY FORWARD: To strengthen the GST Council?

  • The council needs neutral, unbiased advice from top-notch professionals in the field.
  • The finance ministry’s budget-making wing on indirect taxes, called the Tax Research Unit, should be brought under the GST Council.
  • Rightly, roping in competent tax-research officers from states, and having a taxation expert of national stature as the Secretary General (currently steered by the Revenue Secretary) will help strengthen the council’s secretariat.
  • GST subsumed 17 central and state taxes and 23 cesses. It creates multiple audit trails on the income and production chain — throwing up voluminous data. Big-data analytics must be deployed to follow these trails to tax potential.
  • The transaction chain of key raw materials such as metals and petrochemicals must be followed up to unearth the value added escaping tax at the moment.
  • The council should move towards the overall direction to lower and converge rates and prune exemptions that break the GST chain and clutter the tax system. This will minimise classification disputes and make compliance easy.
  • Rate changes should be based on rigorous data analysis. The council must not delay the inclusion of petroleum products, real estate and electricity duty in the GST framework, to widen the tax base, and probably double its current size.

CONCLUSION: The Constitution makes it obligatory for the Centre to make up for shortfall by the States. The cess collected will not be sufficient for this purpose. The GST Council, which is a constitutional body with representation of the Centre and all the States, should find a practical solution to this. Simultaneously, there is a need to strengthen the GST Council.

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December 2022