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.
It asks 3 things — 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, and the way out
Open with · Section 18 of the Constitution (101st Amendment) Act, 2016 required Parliament to compensate States for revenue lost from GST for five years; the GST (Compensation to States) Act, 2017 gave it effect, and the pandemic turned this guarantee into a test of cooperative federalism.
Cover
- Rationale: States surrendered their taxes and GST accrues to the consuming State; 14% growth over the 2015-16 base guaranteed for five years, funded by a compensation cess.
- Price of consent: Article 279A gives the Centre one-third of the weighted vote and every Council decision needs a three-fourths majority.
- COVID-19: the 2020-21 shortfall far exceeded the cess pool; only about Rs 97,000 crore of it was attributed to GST implementation (41st Council, August 2020).
- Tensions: the 'Act of God' stand, two borrowing options, States' demand that the Centre borrow; resolved by special-window loans of Rs 1.10 and Rs 1.59 lakh crore, with the cess continued to repay them.
- Way forward: rule-based revenue protection, buoyancy, and the dispute mechanism that Article 279A(11) requires the Council to establish.
Close with · A guarantee honoured in spirit, transparent cess accounts and a working dispute mechanism under Article 279A(11) will keep the GST Council the model of cooperative federalism it was designed to be.
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.”
- Section 18 of the Constitution (101st Amendment) Act, 2016 obliges Parliament to compensate States for GST revenue loss for five years from GST's implementation (Ministry of Finance, Parliament reply).PIB, Ministry of Finance: Payment of GST compensation to States in times of COVID-19 pandemic (Parliament reply) ↗“as per Section 18 of the Constitution (One Hundred and First Amendment) Act, 2016, Parliament shall, by law, on the recommendation of the Goods and Services Tax Council, provide for compensation to the States for loss of revenue arising on account of implementation of the goods and services tax for a period of five years from the date of implementation of GST.”
- Article 279A(9): GST Council decisions need three-fourths of the weighted votes; the Centre's vote carries one-third weightage and all States together two-thirds.The Constitution of India (as on 1 May 2024), Article 279A(9) - Legislative Department ↗“Every decision of the Goods and Services Tax Council shall be taken at a meeting, by a majority of not less than three-fourths of the weighted votes of the members present and voting, in accordance with the following principles, namely:— (a) the vote of the Central Government shall have a weightage of one-third of the total votes cast”
- Borrowing options after the 41st GST Council (August 2020): the shortfall attributed to GST implementation, about Rs 97,000 crore, to be borrowed under a Special Window coordinated by the Finance Ministry.PIB annexure, Ministry of Finance, August 2020: GST compensation options communicated to States after the 41st GST Council meeting ↗“The shortfall arising out of GST implementation (calculated at Rs. 97,000 crores approximately) will be borrowed by States through issue of debt under a Special Window coordinated by the Ministry of Finance.”
- The same annexure: the compensation cess continues after the transition period until all arrears are paid, with interest and principal on the special-window borrowing as the first charges on it.PIB annexure, Ministry of Finance, August 2020: GST compensation options ↗“The Compensation Cess will be continued after the transition period until such time as all arrears of compensation for the transition period are paid to the States. The first charge on the Compensation Cess each year would be the interest payable; the second charge would be the principal repayment.”
- The Centre borrowed and released Rs 1.1 lakh crore in 2020-21 and Rs 1.59 lakh crore in 2021-22 as back-to-back loans to States (Ministry of Finance, 31 May 2022).PIB, Ministry of Finance, 31 May 2022: Centre Clears Entire GST Compensation Due Till Date ↗“In order to meet the resource gap of the States due to short release of compensation, Centre has borrowed and released Rs.1.1 lakh crore in 2020-21 and Rs.1.59 lakh crore in 2021-22 as back-to-back loan to meet a part of the shortfall in cess collection.”
Question: UPSC's CS (Main) 2020, GS Paper III — paper ↗. Approach: Minimalist IAS, checked 3 Oct 2026 (how we verify) — UPSC publishes no model answers. ·
Model answer· 373words · Minimalist IAS
Section 18 of the Constitution (101st Amendment) Act, 2016 required Parliament to compensate States for revenue lost from GST for five years; the GST (Compensation to States) Act, 2017 gave it effect. The pandemic turned this fiscal guarantee into a test of cooperative federalism.
Rationale behind the Compensation Act
- Loss of tax autonomy: States surrendered VAT, entry tax and other levies; GST accrues to the consuming State, so manufacturing States feared losses.
- Assured growth path: every State's revenue is protected at 14% annual growth over its 2015-16 base for five years from July 2017.
- Dedicated funding: a compensation cess on luxury and demerit goods flows into a Compensation Fund, independent of the Union budget.
- Price of consent: the guarantee won States over in the GST Council (Article 279A), where the Centre holds one-third of the weighted vote and decisions need three-fourths.
How COVID-19 hit the compensation fund
- Collapse in 2020-21: the lockdown crushed GST and cess receipts while protected revenue kept compounding; only about Rs 97,000 crore of the shortfall was attributed to GST implementation, the rest to the pandemic (41st Council, August 2020).
New federal tensions
- 'Act of God' dispute: the Centre argued it need not fund the pandemic-induced gap and offered two borrowing options; States called the guarantee unconditional and the Centre the cheaper borrower.
- Resolution: a special window through which the Centre borrowed Rs 1.10 lakh crore (2020-21) and Rs 1.59 lakh crore (2021-22) as back-to-back loans to States, with the cess continued beyond the transition period to repay them.
- Deeper fault lines: shrinking State fiscal space, delayed dues eroding trust, and a Council in which the Centre alone can block any decision.
- 2016: 101st Amendment
- 2017: Compensation Act and cess
- Aug 2020: two borrowing options
- Oct 2020: special window
Way forward
- Rule-based protection: a transparent formula for revenue support after the transition, not ad hoc borrowing.
- Buoyancy: rate rationalisation and compliance so that the cess pool and State revenues grow together.
- Dispute mechanism: operationalise the body that Article 279A(11) requires the Council to establish to adjudicate Centre-State disputes.
A guarantee honoured in spirit, transparent cess accounts and a working dispute mechanism under Article 279A(11) will keep the GST Council the model of cooperative federalism it was designed to be.
Prepared by Minimalist IAS to the answer standard of Shivam Singh (mentor, 7 years) · facts checked against official sources (how we verify) · updated 3 Oct 2026. UPSC publishes no model answers: compare your structure and coverage with this, then write your own.
