At this month’s meeting of the NITI Aayog’s Governing Council -- chaired by Prime Minister Narendra Modi -- chief ministers of some non-BJP ruled states reiterated their demand to extend the GST compensation cess regime for another five years.

According to a working paper by the National Institute of Public Finance and Policy, Punjab, Goa and Chhattisgarh may face the most revenue stress once the compensation regime ends.

But the Centre remained non-committal. There was no word on it even after the previous GST council meeting in June, which had coincided with the completion of five years of the GST regime. As many as 16 states spoke on the compensation, with some pitching for extension at least a few years, if not for five years. The GST compensation mechanism was designed to make up for the loss of states’ revenue on account of the regime’s implementation five years ago. The five-year compensation period ended in June this year.

The goods and services tax (GST) collections have remained upbeat for the past few months, staying above Rs 1.4 trillion for five straight months ending July. In fact, July’s collection was the second-highest since the rollout of the indirect tax regime. The strong GST collections could weaken the states’ demand to extend the compensation beyond June 2022.

Former Finance Secretary Hasmukh Adia in a recent interview with a business daily said that if the compensation is continued for too long, it will act as a disincentive in increasing collections and lead to laxity of state bureaucracy. The Centre also said it had already cleared arrears worth Rs 85,000 crore and will front-load the remaining ones so that states don’t face any cash flow problem.

Even if the compensation were to be extended, there is the question of how it would be funded. Though the GST compensation cess will be levied till 2026, it will only be used to repay the GST compensation cess shortfall that arose in the last two years due to pandemic. The Centre had borrowed Rs 1.1 trillion in 2020-21 and 1.59 trillion in 2021-22 in loans from the market to provide compensation to states.

According to MS Mani, Partner, Deloitte, GST collections are robust in the past few months. States may be in genuine need to have more funds at their disposal. The need for more funds may not necessitate the extension for compensation period

On the other hand, some states argue that their finances have not recovered yet from the pandemic. States’ revenue receipts declined by 0.6% in FY21 and a similar decline was seen in FY20. An RBI report has recently highlighted that states’ fiscal positions deteriorated sharply in 2020 and there are warning signs of building stress. States relied on compensation to achieve 23% of the guaranteed revenue in 2019-20 and 36% in 2020-21.

Then there is also the question of whether the GST regime has helped in incremental revenue for states. According to an India Ratings report, the state’s GST on an average grew by 6.7% during FY18-FY21, lower than the 9.8% growth recorded by the taxes subsumed under GST during FY14-FY17.

During FY19-FY22, Odisha was the only state having average SGST collection exceeding 14%, with a total of 17 major states recording average SGST growth of below 10%, the report noted. The compensation was promised based on the assumption that the state's GST growth rate will be 14% in the base year of 2015-16. So, does this warrant for a compensation extension?

NR Bhanumurthy, Vice-Chancellor, Dr BR Ambedkar School of Economics University, says increase in GST collections may be largely due to buoyancy. Cessation of compensation may dent states fiscal position. There is a need for central government to handhold states at least for few more quarters

Clearly, experts say there is no case for extension of compensation for another five-year period, but states need some support at least for a few more months. In return, state tax officers also need to be vigilant to check evasions and further improve GST realisations to move away from compensation support once and for all.