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‘Uncooperative’ Federalism

The 15th Finance Commission’s Terms of Reference need moderation, or else states will lose fiscal powers.

The Finance Commission is a constitutional body, an indepen­dent arbiter of resources between the union and the states. The core mandate of the commission is to divide union taxes in a way that enables the union and the states to perform their respective expenditure responsibilities defined in the 7th Schedule of the Constitution of India. Finance commissions in the past had performed this role admirably, and as an institution it earned tremendous respect among all stakeholders. One of the major strengths of India’s federal fiscal structure is an independent finance commission and the role it has played in strengthening federalism in this country. The commission’s mandate is defined by its “Terms of Reference” (ToR). The 15th Finance Commission’s (XV-FC) ToR have raised serious apprehensions among states. Apart from the controversy about the use of the 2011 population instead of 1971, which may result in smaller shares from the common pool of revenues for some states, the ToR are heavily loaded in favour of the union government. Unless a balanced view is taken by the XV-FC, these ToR have the potential to convert an already hierarchical union–state fiscal relation into a relation of command and control. Since this is the first finance commission after the abolition of the Planning Commission, it also needs to take a holistic and balanced view of union and state resources, including the ones that flow outside the commission-recommended route.

The 14th Finance Commission (XIV-FC) was the first to take an aggregate view of resources and expenditures, and recommended a 42% tax devolution to cover both non-plan and plan revenue expenditures of states. At the same time, the XIV-FC’s assessment of union finances from 2015–16 to 2019–20 provided sufficient fiscal resources for the union to perform functions listed in the union list and on national development priorities reflected through centrally sponsored schemes. However, in an unprecedented mandate, the XV-FC has been asked to review the impact of enhanced tax devolution recommended by the XIV-FC on the fiscal situation of the union government along with the continuing imperative of the national development programme, including New India–2022. What is this New India–2022? Can a government whose term ends by 2019 ask the commission to preserve central resources up to 2022 to make somebody else implement its vision? This New India initiative may also proliferate centrally sponsored schemes in social and economic sectors. Further, in a federal system, where state governments are responsible for spending around 58% of the combined expenditure of the union and states, can any national development agenda be set by cutting the flow of resources to states? The implication of the ToR is loud and clear. The union government is keen to reverse the process of greater fiscal autonomy and have greater control over state resources and functions.

Providing the Article 275 grants to the states is an instrument to cover the post-devolution revenue deficits of states. As mandated, “The Commission may also examine whether revenue deficit grants be provided at all.” In fact, if the commission decides to do away with revenue deficit grants, what alternative mechanism will be adopted to meet the post-devolution deficits of states? These ToR, in effect, suggest that the commission should ensure that no state should have a deficit after the tax devolution. This in a way amounts to forcing the commission to justify its unrealistic projection of revenue and expenditure needs of the states.

The ToR are heavily skewed towards conditionalities. As per ToR (7), the commission may consider proposing measurable performance-based incentives for states, at the appropriate level of government in several areas. A number of questions arise in this context. Is the commission the right institution to judge the performance of states and provide incentives? If the core mandate of the commission is to correct fiscal and cost disabilities, where does one introduce incentives? If tax sharing is based on incentives, would the primary role of achieving fiscal equality not be compromised? If this is to be done through a mechanism of grants, does that not automatically reduce the quantum of tax devolution that will make fiscal space for conditional grants? Incentives or grants can always be given by the union government through non-finance commission grants. Why constrain the commission’s functioning through ToR (7)?

Finally, comes the question of debt, deficit and fiscal responsibility. The states, in the aggregate, are fiscally prudent. The all-state fiscal deficit for 2017–18 (budget estimates) is 2.7% of the gross domestic product. Therefore, any conditional reduction of state debt by the XV-FC will have consequences on state-level spending, particularly on development spending. The union government should be asked to improve its fiscal performance, not the states. We must remember that it is the union government that has not adhered to its own Fiscal Responsibility and Budget Management Act targets since 2008.

Updated On : 17th Apr, 2018

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