What are the Central and State Governments fighting over?
The Central and State Governments are fighting. Again. Why? Read on.
The talk of the town is again around God - this time, on a particular “Act” of His.
While one may debate whether it was “Divine Intervention” that caused the virus, one thing is very clear - those in power are once again using this as an excuse to get out of an obligation.
Our Central Government (CG) has gone back on a promise they made to the State Governments (SGs) on July 1, 2017.
No, no. I am not one of those who remember all the important dates in a relationship :P It just so happens that the GST law was passed on that date.
To make the States say ‘Yes’ to GST, the Central Government promised to compensate them for any shortfall in the State’s revenue.
They obviously did not account for the greatest economic crisis to hit mankind.
The Central Government’s contention to not pay this amount is that - since there is no revenue flowing to the Government because of the pandemic, there is no question of sharing that revenue with the States.
Moreover, the CG had levied a Compensation Cess (another tax for us to bear) to compensate the States. This cess is collected from us when we purchase some particular goods or services.
Since no one is purchasing much, this revenue stream has also dried up for the CG.
Not only has the CG refused to hold their end of the bargain, and are relying on a ‘technicality’ in the law, it is also suggesting that the State Governments borrow on their own to meet the shortfall. Later, once the economy stabilises, the CG will compensate the States over a period of time (more empty promises?)
SGs have become ‘high maintenance’ for the CG.
But, what’s the problem? Even if the CG agrees to pay now, it will do so by borrowing from the market and giving it to the States? So, why can’t States just go ahead and do it on their own?
Well, the CG borrows in bulk. Lots of amounts at a go. Plus, it’s easier for other countries to lend to the CG of a country, than to lots of SGs.
Hence, the interest rate at which the Centre borrows < the interest rate at which the States borrow. It would be cheaper for the country if the Centre borrows and passes it on to the States.
But, the larger question is, should we borrow more at all?
To answer this, we first need to understand something called the “crowding out effect.”
Funds to be borrowed from the markets are limited. There are only so many lenders who will give you a loan at a certain interest rate.
As the total borrowings (public + private sector) increases, the cost of loan (called interest rates) tends to increase.
When a Government borrows for meeting its expenditure obligations, it competes with the private sector.
As interest rates go up, profitability for the companies go down. Hence, they don’t borrow at these higher rates.
With lower private investments, there’s lower job creation, higher unemployment, lower wages, lesser goods produced, lower consumption, and hence, lower growth.
So, in this tussle between the CG and SGs, everyone loses.
Maybe the question is no longer about should the government borrow.
Maybe the question now is, how much can we borrow.
Nobody knows the optimum number. But, Prof. Raghuram Rajan suggests the following to be kept in mind when we do:
1. Raise money by selling off as many assets (read: LIC) as you can right now. Borrow as a last resort.
2. Prioritise sectors to be saved based on how many people they employ, how much taxes they pay, how much they add to the economy, etc. and develop relief packages accordingly.
3. We can’t save all the firms. We need to objectively save the most important ones, and let the others die quickly.
4. Borrow, but have a plan for deploying that money strategically (today, the country lacks an economic plan).
A recession is on the cards. Economists are scratching their heads over what could be the best solution to revive the economy. No one has a concrete one, yet.
If nothing else, the pandemic has shown the world that the economic models we have are failing to serve their purpose. Add to that the flavour of ‘politics,’ and you are left with a nation headed towards economic doom.
Will our country stand united and work on finding solutions to the larger problems at hand, or will the CG and SGs keep fighting?
Only time will tell.
Till then, ReadOn.
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Note: We have considered crowding out effect amongst various other factors to make you understand this as simply as possible.
Noob's Corner:
1. Act of God: This is a clause in almost all commercial contracts, which allows the parties to not adhere to the terms and conditions of the contract if any misfortune like floods, earthquake etc. befalls. Our Central Government is using this clause as a shield to protect itself from paying their dues to the State Governments.
2. Compensation Cess: In the GST Act, the Central Government has the power to levy a cess on certain goods and services from time to time, as it deems fit. The government introduced the compensation cess to compensate the States for any loss of revenue they may have had due to GST law being passed.
Why a loss? Some States are 'Producer States,' while other states are 'Consumer States.'
Producer States produce more goods and services than they consume and sell it to other States. Now, the GST is levied on consumption and not production. So, since the producer states don't consume much, their revenue from GST would fall and go to some other State that consumes more.
Hence, to balance this out, the CG intervened and said that it would compensate for the shortfall of the Producer States.
Recommendations:
1. Watch Prof. Raghuram Rajan's interview, where he talks candidly about what we need to do to revive our economy.
2. If you are a beginner and want to learn more about economics, read Freakonomics. Even those studying Economics can read this one - it's super fun!