GST headroom for states with conditions

The tussle over extending the goods and services tax (GST) compensation payout to states beyond June this year continues. Last week, GoI extended the compensation cess until March 2026 only to repay the loans taken to make good the revenue shortfall for states due to the pandemic. This is logical, following the GST Council's recommendations. State finances are in a bad shape. A recent RBI paper (bit.ly/3ympdvQ) expects the fiscal conditions of most indebted state governments to deteriorate further, with their debt-to-gross state domestic product ratio likely to stay above 35% in 2026-27. Given that states' spending accounts for over 60% of total government spending, they need more headroom for social sector expenditure. This bolsters the case for states wanting the Centre to continue the compensation payout to them. If GoI were to agree, the compensation payout must be tied to tight conditions, including an improvement of the states' GST collection effort.

The GST Compensation Act 2017 guarantees a 14% annual growth in tax revenues for the states from the amount collected by them in 2015-16 for five years from FY2018 to FY2022. The cesses are levied on sin and luxury goods including autos, aerated drinks and cigarettes that attract 28% GST. The 14% growth target in GST collections, though, was unrealistic in a slowing economy. This must be reworked. States should also improve tax buoyancy using efficiency gains under GST and digitisation, and muster the political will to levy appropriate user charges in the power sector.

Fewer and lower GST rates will boost consumption and improve compliance. Bringing petro-fuels and real estate under GST will shore up collections significantly. The GST Council should endorse structural reform.