The Centre on Thursday offered the states two options to plug a shortfall in their Goods and Services Tax (GST) revenue, estimated at Rs 2.35 lakh crore in the financial year that ends in March 2021, as the coronavirus disease (Covid-19) pandemic, which finance minister Nirmala Sitharaman likened to an “Act of God”, takes its toll on the economy. State governments were given a week to make a choice, triggering angry reactions from some Opposition-ruled states that said the decisions was thrust upon them.

The states can borrow Rs 97,000 crore at a reasonable interest rate from a special window that will be opened by the central government in consultation with the Reserve Bank of India (RBI), and repay the amount from the cess charged on luxury and sin goods such as liquor, cigarettes, aerated water and automobiles, after the GST regime completes five years of implementation in June 2022.

The second option is for the states to borrow the entire Rs 2.35 lakh crore in consultation with the central bank. Some Opposition-ruled states insisted that the Centre borrow the money instead and compensate the states for the shortfall.

“We told them that we will facilitate talking with RBI and help getting G security-linked interest rates so that each state does not have to struggle for loans,” finance minister Sitharaman said after a five-hour 41st meeting of the GST Council, which is headed by her and comprises state finance ministers.

“The states have requested us to lay down both options in detail, and give them seven full working days to deliberate on it and get back. A brief GST Council meeting may be held again,” she said.“Once the arrangement is agreed upon by GST Council, we can proceed fast and clear these dues and also take care of the rest of financial year.”

Sitharaman ruled out any general tax rate hike in the immediate future. The cess on luxury and sin goods will be extend beyond June 30, 2022, for at least another five years.

“Not considering any rate increases to make up for the shortfall in cess is a welcome measure; however, moving to a market borrowing mechanism which would extend the tenure of the cess beyond five years would worry businesses that are subject to the cess,” said MS Mani, partner at Deloitte India.

“Any decision to extend the cess beyond five years in order to fund the present compensation deficit could become a precedent; hence the period of extension of the cess should be minimal and predefined so that the cess does not become a permanent tax,” he said.

“While it is essential to fund the compensation deficit of states, it is also necessary to focus on the overall GST collection deficit confronting both the Centre and the states,” he added.

States can exceed their borrowing limit by half a percentage point under the Fiscal Responsibility and Management (FRBM) Act, and can choose to borrow more than the expected compensation from the Centre.

In May, their borrowing limit was raised from 3% of respective gross state domestic product (GSDP) to 5% that would give them additional resources of Rs 4.28 lakh crore during the Covid-19 crisis.

The options spelled out by Sitharaman will be available only for this financial year. In April 2021, the Council will review and decide action for the fifth year.

When the new indirect tax regime came into force in July 2017, states were assured a 14% increase in their annual revenue for five years (up to 2022) and that any shortfall would be made good through the compensation cess levied on luxury goods and sin products. Both GST and cess collections have slumped this year mainly on account of the Covid-19 pandemic.

“…you are facing an Act of God which might even result in a contraction of the economy (this fiscal year),” Sitharaman said.

In the period from April to July, the total GST compensation to be paid to states came to Rs 1.5 lakh crore because of the nationwide lockdown for the coronavirus that indirect revenue collection, finance secretary Ajay Bhushan Pandey said.

The annual compensation is expected to come to Rs 3 lakh crore, of which the cess would cover Rs 65,000 crore, leaving a gap of Rs 2.35 lakh crore.

Of the Rs 2.35 lakh crore shortfall, Rs 97,000 crore would be because of a decline in GST collection and the rest attributable to the pandemic. The central government released more than Rs 1.65 lakh crore in GST compensation to the states in the 2019-20 fiscal year, more than the Rs 95,444 crore that was collected in the form of cess.

Some state governments governed by parties that are not in the ruling National Democratic Alliance (NDA) at the Centre have opposed the proposal that they borrow money to make good the shortfall in revenue.

Finance secretary Pandey said attorney general KK Venugopal has advised the central government that the compensation cannot be paid by drawing money from the Consolidated Fund of India, the repository of all revenues received by the government by way of direct and indirect taxes and money borrowed.

“There may be some states which may prefer to get hard-wired compensation rather than going to the market to borrow more. Option was tailor-made considering that states can take a call depending on compensation they expect to come,” Sitharaman said.

Delhi finance minister Manish Sisodia accused the Centre of “betraying” federalism by “refusing” to pay GST compensation to states, and demanded it take loan from the RBI on behalf of the city government which he said is facing a revenue shortfall

West Bengal finance minister Amit Mitra on August 26 wrote to Sitharaman that states should not be asked to borrow from the market.

“The Centre must pay the compensation from the different cesses that it collects, as it is not getting devolved to the states. In case of a shortfall it is the responsibility of the Centre to garner resources for fully compensating the states, as per the formula agreed upon with the states,” Mitra wrote.

In 2017, 28 states agreed to subsume their local taxes such as value added tax into the new, nationwide GST, which was billed as the biggest tax reform in post-Independence India. Under the GST structure, taxes are levied in four slabs — 5%, 12%, 18% and 28%. On top of the highest tax slab is the cess.

“Under no circumstances, states should be asked to borrow from the market as it will increase their debt servicing liability. Further, it may lead to cut in state expenditure which is not desirable at this juncture when the economy is witnessing a severe recessionary trend,” he wrote in the letter reviewed by Hindustan Times.

Reminding Sitharman of her promise to pay compensation to states at the 39th meeting of the GST Council, Mitra wrote that the tax regime had been hailed the world over as an example of cooperative federalism, which is based on mutual trust.

“Some dent in this trust has already been made due to delayed payment of GST Compensation. Let us not do anything that will give a death blow to this unique collective effort,” he said in the letter.

The finance ministers of Congress-ruled states said they were not happy with the outcome of the meeting as decisions were thrust upon them by the Centre, Punjab’s FM Manpreet Badal said. “We are not happy at the outcome. But, we have no choice,” he said.

Chhattisgarh finance minister TS Singhdeo said the central government must act as an elder in the family and ensure that states’ share of revenue from GST is protected instead of asking the states to borrow.

“Why should states take loans individually rather than Government of India doing it,” he asked.

The Congress on Thursday said it was “dissatisfied” with the outcome of the GST Council meeting and accused the Centre of adopting a majoritarian approach and thrusting “solutions” on states.

Telangana, ruled by the Telangana Rashtra Samithi (TRS), demanded the release of Telangana’s share of Rs 2,700 crore towards Integrated GST.

“All the states have joined the GST as the Centre had assured them that joining the GST will not cause any loss to the revenue of the states. The responsibility for paying GST compensation lies entirely with the Central government,” Telangana finance minister Harish Rao said.

Kerala finance minister Thomas Isaac said ministers of the Opposition-ruled states who attended the GST council meeting to discuss non-payment of compensation to the states felt a big letdown as the Centre continued to thrust its solutions on them.

“It was another let down. The GST council should have empowered to borrow for meeting the compensation requirement, if necessary through an ordinance. Part payment of compensation is not enough in such trying times,” said Isaac.

The finance ministers of ruling Bharatiya Janata Party (BJP) governments demanded immediate payment of GST compensation.

At the GST council, Uttar Pradesh asked for payment of around Rs 12,000 crore compensation for the revenue shortfall caused largely by the Covid-19 lockdown during the current financial year.

Finance minister of another BJP-ruled state, Madhya Pradesh, Jagdish Devda thanked the Union finance minister for releasing Rs 2,600 crore against GST compensation and urged her to release the remaining amount of Rs 5,995 crore.

“The only agenda of the meeting was compensation to be paid to the states due to drop in the GST revenue. There was elaborate discussion on the issue. There was an almost unanimous view that loans should be taken from Reserve Bank of India to compensate the loss,” he said.

(Agencies contributed to this story)