Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions?
Approach · directive: “explain / how”
What it asks · Explain why states were promised compensation when GST replaced their own taxes, and how the pandemic drained the fund and pitted the Centre against the states.
The question has 3 parts — answer each
- Explain the rationale behind the GST (Compensation to States) Act, 2017
- Explain how COVID-19 hit the GST compensation fund
- Show the new federal tensions this created
Open with · GST subsumed most state taxes; to win states' consent, Parliament assured them compensation for revenue loss in the transition years through the GST (Compensation to States) Act, 2017.
Cover
- Rationale: states gave up much of their power to tax and feared losses, especially manufacturing states, as GST accrues to the place of consumption.
- Mechanism: for five years, states were assured 14% yearly growth over 2015-16 revenue; a cess on luxury and demerit goods funded the shortfall.
- Before COVID: the 2019-20 slowdown had already left cess collections short, and payments to states were delayed.
- COVID-19 impact: the lockdown collapsed GST and cess collections in 2020-21, so the shortfall far exceeded the cess pool.
- Federal tensions: the Centre called the pandemic an ‘Act of God’ and offered borrowing options, while states demanded that it borrow and pay.
- Resolution: the Centre later agreed to borrow through a special window and pass the funds to states as back-to-back loans.
- Deeper issues: states' loss of tax autonomy, the Centre's one-third vote weight in the GST Council (Article 279A), and doubts over who must borrow.
Close with · GST compensation was the price of cooperative federalism; a lasting fix needs a predictable revenue guarantee, more buoyant state revenues and consensus in the Council.
Add value (verified)
- The Ministry of Finance states the guarantee in its own words: 14% annual growth over the 2015-16 base year, with any shortfall compensated. GST compensation to States for loss of revenue arising on account of implementation of GST for a period of five years, Ministry of Finance, PIB (19 July 2022) ↗“During transition period, the States’ revenues are protected at 14% growth rate per annum over the base year revenue (2015-16). Accordingly, the States are being compensated for any shortfall against their protected revenue.”
- The Centre resolved the 2020-21 shortfall by borrowing Rs 1.10 lakh crore through a special window set up in October 2020, on behalf of the states, and passing it on as back-to-back loans. 100 percent of the estimated GST compensation shortfall of Rs.1.10 Lakh crore released, Ministry of Finance, PIB (March 2021) ↗“The Government of India had set up a special borrowing window in October, 2020 to meet the estimated shortfall of Rs.1.10 Lakh crore in revenue arising on account of implementation of GST. The borrowings are being done through this window by the Government of India on behalf of the States and UTs.”
Question: UPSC's CS (Main) 2020, GS Paper III — paper ↗. Approach: Minimalist IAS, checked 30 Sept 2026 (how we verify) — UPSC publishes no model answers. ·
Model answer · 321 words (UPSC limit 250) · Minimalist IAS
GST subsumed most of the states' own indirect taxes. To secure their consent, Section 18 of the Constitution (101st Amendment) Act, 2016 required Parliament to compensate states for revenue loss for five years, which the GST (Compensation to States) Act, 2017 gave effect to.
Rationale for the Act
- Loss of autonomy: states surrendered much of their power to tax and feared losses, especially manufacturing states, since GST accrues to the state of consumption.
- Assurance: for five years from July 2017, each state's revenue is protected at 14% annual growth over its 2015-16 base; any shortfall is paid from a compensation cess on luxury and demerit goods credited to a dedicated fund.
- Trust: the guarantee was the price of cooperative federalism, letting states accept a common tax without fear.
COVID-19 and the fund
- Already strained: the 2019-20 slowdown left cess collections short of the 14% promise, and payments were delayed.
- Collapse: the 2020 lockdown crashed GST and cess receipts in 2020-21 while protected revenue kept growing at 14%, so the shortfall far exceeded the cess pool.
New federal tensions
- The Centre called the pandemic an 'Act of God', argued that it was not bound to fill a gap the cess could not cover, and offered states two borrowing options; states, led by opposition-ruled ones, replied that the guarantee was unconditional and that the Centre, which borrows cheaper, should borrow.
- Resolution: the Centre set up a special borrowing window in October 2020, borrowed Rs 1.10 lakh crore on behalf of the states and passed it on as back-to-back loans in lieu of cess releases.
- Deeper issues: states' loss of tax autonomy, the Centre's one-third vote weight in the GST Council (Article 279A), where decisions need a three-fourths majority, and a trust deficit over delayed dues.
GST compensation was the price of cooperative federalism; a lasting fix needs a predictable revenue guarantee, more buoyant state revenues and consensus in the Council rather than numbers.
Written by Minimalist IAS from facts checked at source (how we verify) — a little fuller than exam length, so every part of the question is covered; in the hall, keep the structure and trim the detail. UPSC publishes no model answers: compare your structure and coverage with this, then write your own.