Budget crisis of States in Covid-19 economic slowdown
I wrote an article on what Central Govt needs to do on Budget making in this pandemic emergency. But our Politicians, Ministers, Policy makers & Policy advisers have very different view of the economic situation. For Modi Govt, the economic shock which India is facing is just a discrepancy of numbers. The rise in fiscal deficits, fall in tax collections, downgrade of India's sovereign credit ratings, amount of GST compensation to states etc - Modi Govt only think about managing these numbers without thinking about the actual underlying economic catastrophe going on in India. There is rapidly rising unemployment, collapse of demand, collapse in private & Govt capital investment, failure of businesses, personal bankruptcy of people & losses in MSME sector, failure of healthcare system as its overburdened & ultimately rising poverty & falling standards of living in middle class & lower class segments of population. All these things are not new and they have been going on under Modi's leadership since last 4 years. But with Covid-19 economic shock, all these things have now greatly accelerated.
India GDP growth in continuous decline long before Covid-19 Pandemic emerged. Photo - Scroll.in
To fight this economic slowdown in Pandemic, Central Govt needs to provide extraordinary amount of fiscal support to economy and States. Focusing on States, its a fact that States will bear the biggest brunt of this economic shock due to several reasons. Firstly, the States do not have power to issue their own money. Hence, every rupee deficit of States has to be covered either by tax collection or by borrowing from markets. Borrowing from markets is not easy as States have to pay exorbitant interest rates on its Bonds. Also Tax collections will remain depressed in this economic slowdown. But secondly, GST has created another problem with State's powers on tax collections. States gave away their fiscal autonomy to Central Govt by agreeing to GST Act. So States don't have liberty to raise Taxes or create new Taxes (apart from on Petrol/Diesel etc) to manage their fiscal deficit. Raising taxes is by no means a solution in this economic slowdown but now States are facing a worse alternative. That is drastic cutting spending, austerity & budget cuts, cutting capital expenditure, cutting & delaying salaries, pensions of State Govt employees & other critical obligations.
GST Act was supposed to create One-India-One-Market economy with centralization and uniformity of Tax code. States conceded their fiscal autonomy to Central Govt in constitutional amendment of GST Act. One of the conditions of GST Act was States getting assured 14% increase in tax collections in first 5 years of GST Act. While this assured payment of states was based on ambitious estimation of Tax increases, many policy advisers including IMF projected that India's GDP will increase by 2% due to new Tax code alone. So compensation payments to states by Central Govt, if their revenue collection does not achieve ambitious target of 14% increase every year, was not any cause of concern. Also this GST compensation was paid to States not just to safeguard against early disruption due to new tax code but also as an incentive to them to make the whole GST idea more attractive to states. This was the vision of GST Act, a Center-State relationship of Co-operative federalism with Central Govt & State Governments sharing revenue collection with mutual understanding of each others needs and goals.
But the problems with GST started even before the Pandemic. Central Government started delaying compensation to States since last year. This was due to many reasons. Firstly, the whole idea that GST alone will raise India's GDP by 2% turned out to be wrong. Secondly, GST itself was highly flawed in its implementation requiring big changes & tweaks throughout last 3 years. Thirdly, GST caused huge disruption to economy & specially in post Demonetization era which shrunk Indian GDP in last Quarter of 2016 & early 2017. This economic decline was not captured by official GDP figures due to calculation jugglery. Finally, the leakages in tax collection continued even in GST era as Govt finds it hard to monitor input tax credit. Many problems that existed pre-GST time continue to mar present tax system too.
As the revenue collection collapsed, the Central Government didn't provide any significant fiscal support to states in these challenging times. The Covid-19 relief financial package only amounts to about 1% of India's GDP on fiscal front. Instead of direct fiscal spending & assistance to states, Govt is choosing indirect ways of credit & loans to private sector. This is not bad but its insufficient in present crisis. The businesses are not in a condition to take debt & start a profitable venture in present economic climate. And this cycle of credit expansion in present depressed economic climate will create more bank NPAs as has been the trend in last several years. Also Govt is reneging from its responsibility on job creation. In fact, new mantra of Govt is that instead of being job seekers, people should themselves become job providers. Govt spending is income of non Govt sector directly or indirectly. Money spent by Govt will be income of people which in turn will spend that money for consumption, thus boosting demand in economy. This cascading effect will keep the economy going. But only Central Government has the unconstrained power to spend money (only constraint is inflation) not the State Governments.
Coming to topic of GST compensation in regards to present time in Pandemic. The revenue collection of States fell massively but States hoped that they have an alternative - the central Govt though did not provide any fiscal support to states, will eventually provide GST compensation to States as promised by GST Act. But then, in an unexpected move the Central Govt invoked "Act of God" excuse that Center cannot provide GST compensation to States in this economic slowdown because Covid-19 is an Act of God and completely unexpected disruption of economy. This brings us back to bigger question.
I agree that nobody expected a Pandemic and massive economic shock when GST was formulated. But the crisis of States is NOT just about GST compensation. Its about shortfall of revenue and States having no means to raise money to make their budgets. As i explained in April, Central Government must provide full fiscal support to States and they can do it because Central Government has the power to create money. But since central Government ignored this, a new crisis of GST emerged which involves the same underlying point. Center's obligation to States in this times of crisis and central Government running away from its responsibilities. Central Government is not a private business which can fail due to shortfall of revenue. Also Central Government is the FINAL BASTION and INFALLIBLE pillar of country. The "Act of God" excuse to deny GST compensation to States undermines this basic notion and also throws Center-State relationship in doubt.
If Central Government continues to ignore the Budget realities of States, the present economic shock which may be big but unavoidable, will manifest into full fledged failures of State Governments leading to failure & bankruptcy of State & public institutions, shutdown of Government operations & Capital investment, disruption in disbursal of salaries & pensions of government employees, cutbacks in State programs, Austerity policies like cutting welfare spending etc and paralysis of all kind of State functions. This is precisely what we don't need in this economic slowdown induced by Covid-19. Modi Government should think not just about present economic shock but should think of coming economic disaster in next 2 years, 3 years and 5 years down the line if Central government doesn't understand its priorities and take steps to tackle them. Real goal should be avoiding that disaster.
Correction - GST compensation is based on 14% annual growth in tax collection. This was erroneously written as 15% in article.
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