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? (Answer in 250 words)

The GST subsumed several state taxes and created a common indirect-tax market. Since this reform restricted states’ independent indirect-tax space, a statutory compensation mechanism was created to protect their revenues during transition.

• The GST (Compensation to States) Act, 2017 guaranteed compensation for five years from implementation.
• States’ protected revenue was calculated using a 14% annual growth base over their specified 2015–16 revenue.
• Compensation was financed through a GST compensation cess on selected luxury and demerit goods.
• The arrangement built trust in cooperative federalism and facilitated states’ consent to GST.

• Lockdowns and economic contraction reduced GST collections, while health, welfare and livelihood expenditure rose.
• Cess collections became insufficient to cover the protected revenue gap, creating a compensation shortfall.
• The dispute concerned whether the shortfall was a normal revenue gap to be financed by the Centre or a shortfall caused by an extraordinary event outside the Union’s obligation.
• States faced borrowing pressures and uncertainty over fiscal planning, while the Centre invoked the force-majeure interpretation and later offered borrowing options.

The episode exposed the tension between assured compensation and the constitutional design of GST decision-making. It also highlighted states’ dependence on pooled taxes, the need for transparent fiscal burden sharing and the limitations of cess-based financing.

Future arrangements should clarify extraordinary-event liabilities, improve compensation forecasting, strengthen the GST Council’s consensus process and preserve adequate untied fiscal space for states.

Keywords: cooperative federalism, compensation cess, protected revenue, GST Council, fiscal autonomy, force majeure.