The state governments may face a Goods and Services Tax compensation shortfall of Rs 2.7 to Rs 3 lakh crore from the Centre in the next financial year (2021-’22), PTI reported on Tuesday, quoting a report by rating agency ICRA. Of this amount, Rs 1.6 to Rs 2 lakh crore will be due to shortfall in cess collection, the report said.

The report, released by ICRA on Monday, said that the shortfall will force states to borrow at least Rs 2.2 lakh crore from the markets. This will amount for 90% of their enhanced borrowing limit, as recommended by the 15th Finance Commission for the next financial year, PTI reported.

The commission has recommended that the normal limit for net borrowings of states be fixed at 4% of Gross State Domestic Product, higher than the usual borrowing limit of 3%. However, the GST shortfall and subsequent borrowing will eat up into most of the increased limit, the report suggested.

“Based on the Centre’s GDP estimate for FY22, we project the enhanced borrowing of 1% of Gross State Domestic Product or Rs 2.2 lakh crore by the states as we estimate a shortfall in GST compensation from the Centre to the tune Rs 1.6-2 lakh crore, taking the overall GST compensation shortfall to Rs 2.7-3 lakh crore in FY22,” said Jayanta Roy, group head of corporate sector rating at ICRA.

Meanwhile on Monday, the Union finance ministry said in a statement that the GST compensation shortfall of Rs 1.1 lakh crore for the current fiscal year (2020-’21) has been fully released to the states.

The total GST revenue shortfall for states in the current fiscal was estimated at Rs 3 lakh crore, of which compensation cess collection was estimated at Rs 65,000 crore, leaving a compensation deficit of Rs 2.35 lakh crore.

Of this Rs 2.35 lakh crore, Rs 1.1 lakh crore has been estimated as shortfall on account of GST implementation, while the rest is being estimated as the impact of the coronavirus pandemic. The Centre, in October 2020, had said that it will borrow the amount under a special window and pass it on to states as a back-to-back loan in lieu of GST Compensation Cess releases.

What is GST compensation?

The Constitution (One Hundred and First Amendment) Act, 2016, which effected the implementation of GST in 2017 has a provision to compensate the states for loss of revenue arising out of the new tax regime. The provision says that revenue shortfalls arising from the transition to the new indirect taxes regime would be compensated from a pooled GST Compensation Fund for a period of five years, till 2022.

This corpus, in turn, is funded through a compensation cess that is levied on so-called “demerit goods”, like cigarettes. The shortfall is calculated annually by projecting a revenue assumption based on 14% compounded growth from the base year’s (2015-2016) revenue and calculating the difference between that figure and the actual GST collections in that year.