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In the last few weeks, after the 16th Lok Sabha election, there has been some debate around powers of the central government to remove Governors. News reports have suggested that the central government is seeking resignations of Governors, who were appointed by the previous central government. In this blog, we briefly look at the key constitutional provisions, the law laid down by the Supreme Court, and some recommendations made by different commissions that have examined this issue. What does the Constitution say? As per Article 155 and Article 156 of the Constitution, a Governor of a state is an appointee of the President, and he or she holds office “during the pleasure of the President”. If a Governor continues to enjoy the “pleasure of the President”, he or she can be in office for a term of five years. Because the President is bound to act on the aid and advice of the Council of Ministers under Article 74 of the Constitution, in effect it is the central government that appoints and removes the Governors. “Pleasure of the President” merely refers to this will and wish of the central government. The Supreme Court’s interpretation In 2010, a constitutional bench of the Supreme Court interpreted these provisions and laid down some binding principles (B.P. Singhal v. Union of India). In this case, the newly elected central government had removed the Governors of Uttar Pradesh, Gujarat, Haryana and Goa in July, 2004 after the 14th Lok Sabha election. When these removals were challenged, the Supreme Court held:
In summary, this means that the central government enjoys the power to remove Governors of the different states, as long as it does not act arbitrarily, without reason, or in bad faith. Recommendations of Various Commissions Three important commissions have examined this issue. The Sarkaria Commission (1988) recommended that Governors must not be removed before completion of their five year tenure, except in rare and compelling circumstances. This was meant to provide Governors with a measure of security of tenure, so that they could carry out their duties without fear or favour. If such rare and compelling circumstances did exist, the Commission said that the procedure of removal must allow the Governors an opportunity to explain their conduct, and the central government must give fair consideration to such explanation. It was further recommended that Governors should be informed of the grounds of their removal. The Venkatachaliah Commission (2002) similarly recommended that ordinarily Governors should be allowed to complete their five year term. If they have to be removed before completion of their term, the central government should do so only after consultation with the Chief Minister. The Punchhi Commission (2010) suggested that the phrase “during the pleasure of the President” should be deleted from the Constitution, because a Governor should not be removed at the will of the central government; instead he or she should be removed only by a resolution of the state legislature. The above recommendations however were never made into law by Parliament. Therefore, they are not binding on the central government.
Later this week, the GST Council will meet to discuss the issue of GST compensation to states. The central government is required to compensate states for any loss of revenue they incur due to GST. The Centre must pay this compensation on a bi-monthly basis, but over the past one year these payments have been delayed by several months due to lack of funds. The COVID-19 pandemic and the consequent lockdown have amplified the issue manifold, with both centre and states facing a revenue shortfall, limiting the ability of the Centre to meet states’ compensation needs.
Why is the Centre required to compensate states for GST?
With GST implementation in 2017, the principle of indirect taxation for many goods and services changed from origin-based to destination-based. This means that the ability to tax goods and services and raise revenue shifted from origin states (where the good or service is produced) to destination states (where it is consumed). This change posed a risk of revenue uncertainty for some states. This concern of states was addressed through constitutional amendments, requiring Parliament to make a law to provide for compensation to states for five years to avoid any revenue loss due to GST.
For this purpose, the GST (Compensation to States) Act was enacted in 2017 on the recommendation of the GST Council. The Act guarantees all states an annual growth rate of 14% in their GST revenue during the period July 2017-June 2022. If a state’s GST revenue grows slower than 14%, such ‘loss of revenue’ will be taken care of by the Centre by providing GST compensation grants to the state. To provide these grants, the Centre levies a GST compensation cess on certain luxury and sin goods such as cigarettes and tobacco products, pan masala, caffeinated beverages, coal, and certain passenger vehicles. The Act requires the Centre to credit this cess revenue into a separate Compensation Fund and all compensation grants to states are required to be paid out of the money available in this Fund.
How much compensation is provided to states?
For 2018-19, Centre gave Rs 81,141 crore to states as GST compensation. However, for the year 2019-20, the compensation requirement of states nearly doubled to Rs 1.65 lakh crore. A huge increase in requirement implies that states’ GST revenue grew at a slower rate during 2019-20. This can be attributed to the economic slowdown seen last year, which resulted in a nominal GDP growth of 7.2%. This was significantly lower than the 12% GDP growth forecast in the 2019-20 union budget (Figure 1).
Figure 1: GDP growth rate (2017-21)
Sources: Union Budget Documents; MOSPI; PRS.
In 2019-20, the gross GST revenue (Centre+states) increased by just 4% over the previous year. Despite this, due to the compensation guarantee, all states could achieve the growth rate of 14% in their GST revenue – much higher than the overall growth in GST revenue. However, there was a delay in payment of compensation from Centre. More than Rs 64,000 crore of the compensation requirement of states for 2019-20 was met in the financial year 2020-21.
What led to a delay in payment of compensation to states?
In 2019-20, the delay in payment was observed due to insufficient funds with Centre for providing compensation to states. These funds are raised by levying a compensation cess on the sale of certain goods, some of which were affected by the economic slowdown. For instance, in 2019-20, sales of passenger vehicles declined by almost 18% and coal offtake from domestic coal companies reduced by nearly 5%, over the previous year. As a result, cess collections registered a growth of just 0.4% in 2019-20 (Figure 2), against the 104% increase seen in the compensation requirement of states. This resulted in a shortfall of funds of nearly Rs 70,000 crore.
Figure 2: Cess collections insufficient for providing compensation
Note: In 2017-18, GST was implemented for only nine months. Compensation amount shown may not match with the amount released in that financial year because of delay in releases.
Sources: Union Budget Documents; Ministry of Finance; GST Council; Lok Sabha Questions; PRS.
How can compensation be paid to states if cess collections are insufficient?
The shortfall in collections for 2019-20 was met through: (i) surplus cess collections from previous years, (ii) partial cess collections of 2020-21, and (iii) a transfer of Rs 33,412 crore of unsettled GST funds from the Centre to the Compensation Fund. These unsettled funds are GST collections, generated in 2017-18 from inter-state and foreign trade, that have not yet been settled between centre and states.
In the 2020-21 budget, the Centre has estimated a 10% growth in nominal GDP. However, due to the impact of COVID-19 and the lockdown, the actual growth in 2020-21 is likely to be much lower. In such a scenario, states’ GST revenue would also be much lower than expected, thus leading to a higher compensation requirement. However, the ability of Centre to pay compensation depends on the cess collections, which are also getting impacted this year. For instance, cess collections during the period Apr-Jun 2020 have been 41% lower in comparison to the same period last year. Moreover, of the Rs 14,482 crore collections made during this period, Rs 8,680 crore has been likely used up for paying compensation for 2019-20.
Note that under the GST (Compensation to States) Act, 2017, Centre can provide compensation to states only through the money available in the Compensation Fund. The Union Finance Minister, in her budget speech in February 2020, clarified that transfers to the Fund would be limited only to collections of the GST compensation cess. Despite a shortfall of money in the Compensation Fund, the Centre is constitutionally obligated to meet states’ compensation requirement for a period of five years.
Various measures have been suggested to address the issue of shortfall in the Fund, either by reducing the compensation payable to states (which would require Parliament to amend the Act following GST Council’s recommendation) or by supplementing the funds available with Centre for providing compensation to states. The Act allows the GST Council to recommend other funding mechanisms/ amounts for credit into the Compensation Fund. For example, one of the measures proposed for meeting the shortfall involves Centre using market borrowings to pay compensation to states, with the idea that these borrowings will be repaid with the help of future cess collections. To enable this, the GST Council may recommend to Centre that the compensation cess be levied for a period beyond five years, i.e. post June 2022.
Impact on states post 2022
In 2019-20, except for a few north-eastern states, most states saw their compensation requirements increase multifold by 2-3 times, over the previous year’s figures. Table 1 shows the compensation requirement of states for the years 2018-19 and 2019-20. Six states (Delhi, Gujarat, Karnataka, Maharashtra, Punjab, and Tamil Nadu) accounted for 52% of the total requirement of compensation for 2019-20. Further, in some states such as Punjab and Delhi, compensation grants form a significant share of the overall revenue receipts (20% and 16% resepctively).
Note that states have been guaranteed compensation only for a period of five years. After June 2022, states dependent on compensation will observe a revenue gap due to a cut in these grants coming from Centre. States have roughly two years to bridge this gap with other tax and non-tax sources to avoid a potential loss of revenue, and a consequent fall in the size of their state budget, which could adversely affect the economy. To what extent will such concerns be alleviated remains to be seen based on the course of action decided by the GST Council.
Table 1: GST compensation requirement of states for 2018-19 and 2019-20 (in Rs crore)
|
State |
2018-19 |
2019-20 |
% increase in compensation requirement |
||
|
Amount |
As a % of revenue |
Amount |
As a % of revenue* |
||
|
Andhra Pradesh |
0 |
- |
3,028 |
3% |
- |
|
Assam |
455 |
1% |
1,284 |
1% |
182% |
|
Bihar |
2,798 |
2% |
5,464 |
4% |
95% |
|
Chhattisgarh |
2,592 |
4% |
4,521 |
7% |
74% |
|
Delhi |
5,185 |
12% |
8,424 |
16% |
62% |
|
Goa |
502 |
5% |
1,093 |
9% |
118% |
|
Gujarat |
7,227 |
5% |
14,801 |
10% |
105% |
|
Haryana |
3,916 |
6% |
6,617 |
10% |
69% |
|
Himachal Pradesh |
1,935 |
6% |
2,477 |
8% |
28% |
|
Jammu and Kashmir |
1,667 |
3% |
3,281 |
5% |
97% |
|
Jharkhand |
1,098 |
2% |
2,219 |
4% |
102% |
|
Karnataka |
12,465 |
8% |
18,628 |
11% |
49% |
|
Kerala |
3,532 |
4% |
8,111 |
9% |
130% |
|
Madhya Pradesh |
3,302 |
3% |
6,538 |
4% |
98% |
|
Maharashtra |
9,363 |
3% |
19,233 |
7% |
105% |
|
Meghalaya |
66 |
1% |
157 |
2% |
138% |
|
Odisha |
3,785 |
4% |
5,122 |
5% |
35% |
|
Punjab |
8,239 |
13% |
12,187 |
20% |
48% |
|
Rajasthan |
2,280 |
2% |
6,710 |
5% |
194% |
|
Tamil Nadu |
4,824 |
3% |
12,305 |
7% |
155% |
|
Telangana |
0 |
- |
3,054 |
3% |
- |
|
Tripura |
172 |
1% |
293 |
3% |
70% |
|
Uttar Pradesh |
0 |
- |
9,123 |
3% |
- |
|
Uttarakhand |
2,442 |
8% |
3,375 |
11% |
38% |
|
West Bengal |
2,615 |
2% |
6,200 |
4% |
137% |
Note: Arunachal Pradesh, Manipur, Mizoram, Nagaland, and Sikkim did not require any compensation in 2018-19 and 2019-20.
*Revenue for the year 2019-20 does not takes into account those GST compensation grants which were payable to states in 2019-20 but were released by Centre in the year 2020-21. The percentage figures would be slightly lower if such grants are included in 2019-20 revenue.
Sources: State Budget Documents; Ministry of Finance; Lok Sabha Questions; CAG; PRS.
