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Is the Special Category Status Really Dead?

Govind Bhattacharjee (govind100@hotmail. com) is former Director General of the Offi ce of the Comptroller and Auditor General of India, New Delhi.

Though the Fourteenth Finance Commission report gives an impression that the special category status given to some states has de facto been abolished, the reality is that the benefi ts enjoyed by these states remain well protected. The biggest flaw of the special category mechanism is that the benefits flow in perpetuity without any accountability or performance monitoring of the states. This has made them overwhelmingly dependent on central funding. It is therefore imperative to bring in more accountability into the mechanism of such liberal transfer of funds and their end use.

The finance accounts of most states for 2015–16, the first year of implementation of the Fourteenth Finance Commission’s (XIV-FC) recommendations, are now available, and it may be time to visit the recommendations once again. The XIV-FC had recommended 42% devolution of the net proceeds of the central divisible pool of resources to the states, as against the existing 32% under recommendations of the Thirteenth Finance Commission (XIII-FC). States now have much more fiscal space to spend on their own priorities, instead of depending on the centre.

For other transfers outside the Finance Commission, that is, those made at the behest of the now-defunct Planning Commission, the Finance Commission had recommended setting up of a new institutional mechanism “consistent with the overarching objective of strengthening cooperative federalism,” by limiting discretion, improving design and giving adequate flexibility to the states. This is yet to be acted upon by the government. The earlier plan transfers have now mostly been subsumed in the higher devolution to states, and total transfers to them have registered only modest increases. Apart from devolution of taxes, the commission also recommended grants-in-aid of revenues of states. These included grants of ₹2.87 lakh crore for the urban and rural local bodies, besides grants of ₹1.95 lakh crore during 2015–20 for meeting the revenue deficits of 11 states, including six north-eastern states, Jammu and Kashmir, Himachal Pradesh, Andhra Pradesh, Kerala, and West Bengal.

The taxes are divided among the states on the principles of equity and efficiency, effectively transferring resources from the rich to the poor states on the basis of a formula which differs somewhat from commission to commission, and which factors in population and area of a state, interstate disparities in income, their fiscal and financial fiscal performance, and so on. From the Sixth Finance Commission onwards, the central government had restricted the finance commissions to recommend only non-plan grants, the plan component having been made the prerogative of the Planning Commission. The plan transfers had mostly been dependent on the discretion of the central government; only a part, the Normal Central Assistance (NCA) was formula-based.

Most of the discretionary transfers were made via the centrally sponsored schemes (CSS) of which there were many, and a large part of the total transfers were made outside the state budgets, by direct transfer of funds from the Consolidated Fund of India to the implementing agencies of the respective schemes in the states, thereby depriving the states from exercising any control over the end use of these funds. These discretionary direct transfers have since been abolished, the CSS reduced in number and restructured. The distinction between plan and non-plan expenditure itself has been abolished. The NCA has also since been done away with.

Unfair to Poorer States

The XIV-FC’s recommendations had attracted severe criticisms, especially from the poorer states, on grounds of equity and efficiency. The three sacrosanct, though unwritten principles—equalisation, equity and efficiency—have always guided Finance Commission transfers to ensure that similar standards of delivery of public services may be extended to all states, and also to prevent economic migrations across states.

Table 1 (p 26) shows the shares, criteria, and weights for vertical and horizontal devolutions adopted by three Finance Commissions. These are really not much different from each other. Of the criteria used for horizontal distribution of devolved resources among the states, population and area are equity neutral. The XIV-FC had in fact increased the weightage to these factors, benefiting the larger states. Among the equitable and equalising criteria, the XIV-FC has dispensed with the fiscal capacity distance criterion used by the XIII-FC, and replaced it with the income distance criterion giving it a slightly higher weightage (50% as against 47.5%). But the XIV-FC has discarded the efficiency criterion of fiscal discipline that had a weightage of 17.5%. It had introduced a new criterion, forest cover, giving it 7.5% weightage.

There are now no efficiency criteria for the transfers, and the states, especially poor states like Bihar that have kept within their Fiscal Responsibility and Budget Management Act (FRBMA) limits, have been made to suffer a cut in their shares instead of being rewarded for maintaining fiscal discipline. This was even when these states limited spending at the cost of limiting their capital
borrowings despite huge infrastructure deficits. But there were no rewards for resisting populism. The states that had suffered cuts in their shares included, apart from Tamil Nadu, poorer states like Assam, Bihar, Rajasthan, Odisha, Uttarakhand and Uttar Pradesh (Table 2).

Special Category States

With the abolition of the distinction between plan and non-plan expenditure, which was only a logical step after the winding up of the Planning Commission, questions are being raised about its fallout on some of the earlier federal fiscal arrangements inherited from the days when the Planning Commission used to allocate federal resources, albeit extra-constitutionally, to the states. Some of these states were the so-called Special Category States (SCS), a category created by the Planning Commission to address their backwardness. These comprise the eight North East states and the three Himalayan states of Jammu and Kashmir, Himachal Pradesh, and Uttarakhand.

They are located in the remotest parts of the country, and along with the international borders of India, they also share geographical isolation and difficult, inhospitable hilly terrains, which increase the cost of delivery of public services manifold. They are predominantly inhabited by tribals whose primary means of sustenance still remains agriculture, which is again characterised by low productivity due to the primitive methods like shifting cultivation used in the hill areas. These states lack resources and infrastructure, and their finances are also unviable. It was on these considerations that they were given the special category status. Crippled by the combined burden of history and geography, which has produced an overwhelming dependence in them on central transfers for their survival and sustenance, eight of these states were dependent upon central transfers alone (share of divisible pool plus grants) for meeting more than 60% of their expenditure in 2013–14. Government expenditure alone constitutes more than 25% of the gross state domestic product (GSDP) in each of these states (more than 50% in Arunachal Pradesh, Manipur, and Mizoram), and their economies will collapse without the central transfers.

These states were given special plan grants under the Gadgil formula introduced in 1969, when the special category status was accorded for the first time to three existing states—Assam, Nagaland, and Jammu and Kashmir—on the recommendations of the Fifth Finance Commission. Since then, other smaller states were all given the special category status upon their creation until 2001, when only one of the three newly created states, Uttarakhand, was given the status while it was denied to the two other equally backward states, Jharkhand and Chhattisgarh, on the ground that they did not fulfil the Planning Commission criterion of sharing international borders. The criteria itself was fixed arbitrarily by the Planning Commission, a political body not answerable to Parliament; the criteria fixed by it thus lacked parliamentary approval.

The status got these states nearly four times per capita plan assistance compared to the other states (General Category States), through the Gadgil formula that earmarked 30% of the total plan transfers under the NCA for these states. Other than the 30% share of the NCA or Gadgil transfers, these states benefited from the central assistance for the CSS in a liberalised manner. While the pattern of funding of the CSS varied from scheme to scheme (for Mahatma Gandhi National Rural Employment Guarantee Act or MGNREGA, it is 75% by the centre and 25% by the state), the ratio of funding for the SCS under any CSS remained at 90% from central grants and 10% from the individual states.

Besides, there are several incentives available to these states in the form of various excise duty exemptions and income tax holidays for 10 years for setting up new industries, extendable by a further period of five years upon “substantial expansion” of the existing units. However, in the absence of market, infrastructure, especially power, entrepreneurial skills and local resources, these incentives had hardly helped these states to industrialise. They also get certain subsidies, which include capital investment subsidy, transport subsidy, and subsidies with respect to interest, insurance, and so on. For these financial benefits, many other states, like Bihar, Odisha, and the residual state of Andhra Pradesh have been clamouring for this status.

The Gadgil formula certainly benefited these states initially to expand their infrastructure in respect of health, education, power, and rural electrification, and their share in the total transfers also went up as seen in Table 3.

However, the subsequent unchecked proliferation of the CSS and allocation of increasing volumes of resources to these schemes played havoc with the NCA. The situation was further distorted by the transfer of most of the funds meant for the CSS to the implementing agencies of these schemes directly, without routing the money through the state budgets. This was done in the hope that the states, having no control over these funds, would not be able to divert the funds towards their non-plan expenditure for paying salary to their staff. But being direct off-budget transfers, they escaped all legislative, executive and accounting controls, besides the usual internal controls inherent in budget execution, and became conduits for corruption and leakage. Such off-budget transfers were not only illegal and unconstitutional, but also undermined and diluted the authority of the states. They increasingly appropriated funds meant for Gadgil transfers that would benefit the SCS (Table 4).

Most of the CSS were also of questionable utility, besides being ill-designed and shoddily implemented. These, more than anything else, served primarily the political and electoral ends of the ruling dispensation. With their proliferation and appropriation of most of the plan resources, the NCA or Gadgil transfers progressively went on shrinking till they shrank to the point of insignificance, to only 9% of the total plan transfers (Table 5). It was a double whammy for the SCS, for while their number had proliferated from three in 1969 to 11 in 2001, their share of 30% of the NCA had not increased. At the same time, the NCA itself had shrunk beyond recognition. It worsened their resource position severely.

Direct transfers were subsequently abolished in 2013–14. In 2013, CSS were also restructured into 66 schemes, including 17 flagship programmes with significant outlays, and in 2016, they were further restructured into only 28 schemes—six “core of the core” schemes, of which the most important was the MGNREGA, and 22 “core” schemes. In the budget for 2015–16, the NCA was abolished, and with effect from 2017–18, the distinction between plan and non-plan expenditure itself was removed, making the Gadgil formula a thing of the past.

Does it mean that the special category status has also been junked with the formula? Does the special category no longer exist? The finance minister asserted that “special category” was a thing of the past. “After the 14th Finance Commission recommendations, the era of special category status to states has ended,” Finance Minister Arun Jaitley had said in response to persistent demands of Nitish Kumar for Bihar’s special category status (Singh 2015). “I don’t want to go into history. The 14th Finance Commission is a constitutional body. The state would get what has been recommended for it. And, we are also giving additional money to Bihar” (Singh 2015). At that time there was a different ruling dispensation in Bihar. Now that the Bharatiya Janata Party (BJP) has become a part of the ruling coalition, there might be fresh demands for the status, or Bihar might be awarded an equivalent package in terms of funds.

A Thing of the Past?

The XIV-FC did not make any reference to the SCS in its report, unlike the previous finance commissions. However, it must be remembered that finance commission grants were non-plan grants, while SCS benefited mostly from the plan grants. The quantum of finance commission grants did not make much difference to their resources, while the devolution of taxes from the divisible pool was formula-based, in which factors like population, area, fiscal discipline or tax effort mostly went against them. These states benefited primarily from the plan grants, though they received some non-plan grants for bridging their revenue deficits, which still continues. But the non-plan grants have rather been insignificant compared to the plan grants.

To evaluate whether the special category status is still active after the XIV-FC’s recommendations, we have to consider two things—whether there has been a curtailment of resources of these states and whether they have managed to retain their relative advantages vis-à-vis other states. As regards the resources, using the transfers for 2015–16, the first year of the XIV-FC award from the finance accounts, it is seen that for the special category as a whole, the total transfers during the first year under the XIV-FC over the previous year had actually increased by 24.7%, more than most other states. The tax devolutions for the SCS in fact increased by almost 90% (Table 6). Neither had the shares of SCS sufferred any cut, they had in fact registered much higher increases than under the previous commissions (Table 7).

As regards the relative advantages enjoyed by the SCS, the latest restructuring of the CSS had made an important distinction between these and the other states, in terms of the funding pattern of these schemes. For the “core of the core” schemes, it envisaged that the existing funding patterns would continue, which is 90:10 for the SCS between the centre and states, while other states have to bear a higher proportion of expenditure on their own. For the “core” schemes, the restructured CSS states that the 90:10 formula between the centre and states would apply “for the 8 North Eastern States and 3 Himalayan States,” while it would be 60:40 for the other states. Though the term “special category states” has not been used, there is no doubt as to what the eight North East states and the three Himalayan states constitute. Thus, the SCS continue to retain their relative advantages over the other states. In other words, the category is far from being a thing of the past.

I have tried to assess the impact of these concessions using the budget estimates of 2017–18 for Assam, in which ₹3,158 crore and ₹11,492 crore were earmarked for central grants for “core of the core” and “core” schemes, respectively at 90:10 funding pattern. Had it not been for this, Assam would receive ₹2,480 crore less on this account alone during the year. In addition, it would be required to pay a further amount of about ₹2,429 crore on account of the additional contribution for the state’s share. The net impact would be ₹4,909 crore on the revenue of Assam for this year alone, which is more than the benefits it derives from its special category status. Other incentives, subsidies, and tax concessions also remain intact. It would be the same for all the SCS, whose earlier benefits thus remain well protected.

Revisiting Special Category

Since the benefits to these states are allowed to continue, it is imperative to correct the inherent flaws in the mechanism itself. For one thing, the mechanism was not devised to address the deep-rooted structural weaknesses that afflicted these states. Entrenched structural incapacities produced by centuries of isolation, neglect and deprivation cannot be addressed so simplistically, by merely designing a novel pattern of funding. Formulating a coherent and pragmatic strategy by addressing the structural weaknesses was essential for any development, a strategy in which funding would be just one essential element, which need not even be the most important one. But neither was there any coherent strategy, nor was the required supporting institutional set-up adequate to guide these states towards some predefined goal.

The whole structure was thus a diffused mix of visionless short-term tactics. These tactics did little to empower these peripheral, marginalised states or to bring them within the folds of the mainstream. Instead they only created states overwhelmingly dependent on central funding for their survival, unable to negotiate their economic future on their own strength. The other defects of the mechanism were the almost total absence of monitoring and accountability and granting of the special category status in perpetuity to a state, without any performance expectation whatsoever. These are not the ideal conditions for ensuring rapid development, and all it nurtured was complacence and large-scale corruption that had penetrated almost every layer of the political establishment, bureaucracy, and administration.

It is perhaps time to take a relook at the whole arrangement and re-examine the continuation of the special category status of a state in perpetuity. The purpose of development would perhaps be better served by adopting a target-based, time-bound arrangement that is focused on accountability, performance, and monitoring of achievements, with specific performance goals to be achieved by the beneficiary states for the benefits to continue. Only then can these states be motivated to grow faster and become less dependent on the centre.

References

Bhattacharjee, Govind (2016): Special Category States of India, Oxford University Press.

Singh, Abhay (2015): “Era of Special Category Status to States Over: Arun Jaitley,” Times of India, 30 October.

Updated On : 18th May, 2018

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