The Terms of Reference (TOR) of the Fifteenth Finance Commission (XV-FC) have generated a lot of debate and discontent because some Indian states feel that their powers are being taken away. While states that have done better on development indicators are concerned that they are being disadvantaged, the larger concern is about the reversal of India's cooperative federalism. 

What are these terms and what are their implications? 

On 7 May 2018, the Andhra Pradesh government hosted the second round of the Finance Ministers' conclave in Vijayawada to discuss the adverse ToR of the XV-FC. Ministers from Delhi, Punjab, Puducherry, Kerala, and West Bengal participated in this conclave.

Earlier, on 10 April 2018, a group of representatives from Kerala, Karnataka, Andhra Pradesh, and Puducherry had met in Trivandrum.

1.  Discontinuance of Revenue Deficit Grants:

Between 2015 and 2020, 11 states were provided revenue deficit grants by the Fourtheenth Finance Commission.

Revenue deficit grants cover the gap between the state’s revenue and expenditure. The ToR state that the XV-FC may examine whether these should be given at all from now on.

This is in line with the expectations of the Fiscal Responsibility and Budget Management Act, 2003, which recommends that states should maintain a revenue deficit of zero.

This is a provision that states with persistent deficits would expect and need.  How can the XV-FC be asked to overlook these expectations?

2. Restrictions on Loans

The states feel that this condition encroaches on their powers to borrow and spend as they choose.

As per the Constitution, a state cannot raise any loan without the consent of the union, if it has an outstanding loan to the union. However, the ToR recommend that the XV-FC should formulate additional conditionalities for providing consent to states for borrowing.

Any conditions on the state’s ability to borrow will have an adverse effect on the spending by the state, particularly on development.

3. Incentives as Controls:

Performance based incentives will have an influence on policy decisions that the states will take.

This provision is problematic because:

i) it disincentivises independent decision-making by the states, an important tenet of cooperative fiscal federalism; and

ii) it does not hold the union government accountable for its own fiscal prudence and dilutes the joint responsibility that the union and states have.

If common resources are shared based on incentives, then how can the principle of creating fiscal equality be realised? Moreover, how is the XV-FC the right institution to judge the performance of states and provide incentives?

4. Change in Population Data:

The XV-FC is mandated to use Census of India 2011 population data for its recommendations.

This is unlike all FCs (since the Seventh Finance Commission) that have used the 1971 population data for devolution of taxes, duties and grants in aid.

This change to population data from the 2011 census will have asymmetric effects on states. State populations are one of the factors that determine the quantum of resources that states receive.

For 12 states, the change will result in smaller shares in the common pool of revenues. These states which have achieved slower population growth feel that they are being disincentivised, as states with larger populations are expected to be allocated more fiscal resources.

The XV-FC has been appointed at a time when there have been significant changes in India’s fiscal policy establishment. The Planning Commission, which watched over the development needs of the country, has been replaced by the NITI Aayog, which does not have the same powers or functions. This has also meant that the distinction between plan and non-plan expenditure was removed from the budgets of the union and the states from 2017–18. Further, the Goods and Services Tax has been implemented, wherein the union and states share a larger common tax base and there are expected to be changes in revenue collections.

Curated by: Sohnee Harshey [sohnee@epw.in] and Abhishek Shaw