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Ensuring Horizontal Equity: Challenge before the Thirteenth Finance Commission

The Thirteenth Finance Commission needs to make a major departure in the interstate distribution of resources devolved from the centre. Since the Tenth Finance Commission, there has been a discarding of criteria that emphasise redistribution and instead a greater weight has been assigned to new criteria such as tax effort and fiscal discipline. This has defeated the very notion of equity, crucial in an era where interstate disparities are widening.

COMMENTARYJanuary 31, 2009 EPW Economic & Political Weekly14upon the change in formula between awards of the aforesaid FCs, the relatively richer states have managed to gain whereas their poorer counterparts have lost in the diversion of shares from the low income states to middle and high income states” (Lenka and Mallick 2008: 77-78). Table 2 (p 15) highlights the loss of low-income states including Bihar, Orissa and Madhya Pradesh.With this brief background, in the fol-lowing three major issues, namely, distri-bution neutral factors, redistributive fac-tors and fiscal incentive factors, concern-ing horizontal (ie, states inter se) equity and fiscal performance have been dis-cussed, with brief references to some of India’s poorest states.1 Distribution Neutral FactorsWe first discuss the population and area factors in distribution.1.1 Population and AreaThese apparently homogenising criteria of population and area blur a realistic picture of the deprivation of various basic ameni-ties and infrastructure essential for a decent living for a significant number of marginalised groups/communities in highly disadvantaged topography and agro-climatic zones. An idea regarding the intensity of poverty in states dominated by a scheduled tribe (ST) and scheduled caste (SC) population can be had from Table 3 (p 15). It is obvious that states with a higher share of ST-SC population also have a large proportion of them in poverty, which also contributes to higher levels of poverty incidence at the state level as well.For instance, that about two-fifths (38.6%) of Orissa’s population include Table 1: Formula for Allocation of Shared TaxesFactors Relative Weightage (percentages) EFCTWFCDistribution neutral: 17.5 35.0 Population 10.0 25.0 Area 7.5 10.0Redistributive: 70.050.0 Incomedistance 62.5 50.0 Infrastructure(inverse) 7.5 0.0Fiscal incentives: 12.5 15.0 Tax effort 5.0 7.5 Fiscaldiscipline 7.5 7.5Total 100.0100.0Source: Twelfth Finance Commission Report, Table 7.2 and Annexure 7.4.Sincere thanks are due to Tapas Sen and Sakti Padhi for their encouragement and inputs. This article largely draws upon Das (2008).Keshab Das ( is at Gujarat Institute of Development Research, Ahmedabad and Aswini Kumar Mishra ( is with the Indian Institute of Management, Ahmedabad.Ensuring Horizontal Equity: Challenge before the Thirteenth Finance CommissionKeshab Das, Aswini Kumar MishraThe Thirteenth Finance Commission needs to make a major departure in the interstate distribution of resources devolved from the centre. Since the Tenth Finance Commission, there has been a discarding of criteria that emphasise redistribution and instead a greater weight has been assigned to new criteria such as tax effort and fiscal discipline. This has defeated the very notion of equity, crucial in an era whereinterstatedisparities are widening. In an important clarification concern-ing the terms of reference (ToR) of the Thirteenth Finance Commission (THFC), it has been pointed out that More importantly, the Commission is an independent constitutional authority vested with the task of dividing the fiscal resources as an important arbiter and therefore, has to take into consideration the revenue potential of the centre and the states on the one hand and genuine expenditure needs of the centre and the states on the other,irrespective of the wording of the ToR (Rao et al 2008: 53, emphasis added). Even as the Finance Commission (FC) devolutions are not the only or even the most important means to address the significant issue of ensuring equity and minimising regional disparity during eco-nomic reforms, it continues to be of much relevance especially to those states lag-ging behind, in spite of the central plans, 12 FCs and numerous other statal inter-ventions. That is reason enough to recon-sider the nature and adequacy of the exist-ing criteria/parameters at least as far as the redistributive factors are concerned.As a prelude to the following short issue-based discussion, it may be useful to have an idea about the criteria chosen by the two most recent FCs, the Eleventh Finance Commission (EFC) and the Twelfth Finance Commission (TwFC) (Table 1). It has been pointed out that the TWFC has already “reversed” the trend of assigning greater weightage to redistributive factors and reduced weightage for income-neutral factors like population and area (Rajaraman and Majumdar 2005: 3418). Between the EFC andTWFC, whereas the weightage for redistributive factors declined from 70% to 50%, the same for population and area had doubled to 35%. Such a blatant down-grading of redistributive factors adversely affects the interests of the poorer states and could undermine the relevance and contri-bution of FC awards. Similarly, consequent

he correspondence or concordance between specified dimen sions of core vulnerable groups – usually non-working poor – with the incidence of extremely poor is higher than that with the headcount ratio (HCR) across the major states in India. Most states (excepting a few like Kerala and Tamil Nadu which have comprehensive social security measures) are not only providing a paltry amount of social pensions and other limited social security and welfare measures to these destitutes but the coverage is also quite limited. Since the public spending for these measures are non-plan and committed in nature, the THFC should look into this demographic composition of population.

COMMENTARYJanuary 31, 2009 EPW Economic & Political Weekly16by applying per capita income instead of poverty incidence, the losers include rela-tively the poorer states such as Chhattisgarh, Jharkhand and Orissa and even advanced states like Maharashtra, Karnataka, Delhi and Tamil Nadu. The rankings would have been the reverse had poverty incidence been chosen the criterion. This indicates that the relative merits of both the criteria call for scrutiny.3 Fiscal Incentive FactorsIt is important to observe that since the Tenth Finance Commision (1995 onwards), there has been a distinct change (paradigm shift?) in the choice of criteria. The down-right discarding of the “Index of Backward-ness”, “Inverse Per Capita Income” and the “Poverty Ratio” and bringing in new criteria of fiscal performance (“Tax efforts” and “Fiscal discipline”) have to be viewed with concern. Such a move emphasising fiscal performance defeats the very basic objective of equity. Especially, for about four decades since the First Five-Year Plan, with draco-nian policies like freight equalisation, non-revision of royalties on minerals exploited, and a grave siphoning off of the central investment subsidy by the rel-atively advanced states, poorer states like Orissa, Bihar, Assam, Madhya Pradesh, Jharkhand andChhattisgarh haveemerged net losers in the spheres of infrastructure and productive activities, espe-cially, industrialisation (Das 1993 and 1997). Consequently, these policy instruments “have left them starved of investible funds for basic social and economic infrastructure, forcing desper-ate migration to far-flung firms and fields for a pittance. Income from mining royalty for these mineral-rich states has remained abysmally low, as the mineral cess has improved meekly and rarely” (Das 2007). Excepting for atomic and specific strategic minerals in the First Schedule (includ-ing petroleum and gold), the centrally-decided royalty pro-visions have often been irra-tional, not to mention that royalty rates remained very meagre and were hardly re-vised upwards after the 1980s. In fact, with newer rates for key minerals as iron ore, coal, bauxite, manganese and chromium, and those listed in the Second Schedule, international rates are far more sensibly designed, with local interests in focus.Depending upon whether the value addition occurs at source and contributes to the local state, fixing royalty rates across minerals as also regions/states assumes significance and is not an uncommon practice around the world. “While the Centre’s practice of using ad valorem and unit-based rates have been weak on revi-sionsand a degree of arbitrariness, states can explore royalty based on net income, broadly defined to include the gross income received or receivable as the prod-uct of capital, labour, land and skill. Even between states, for inter-governmental transfers, a competitive surcharge provi-sion would help” (Das 2007). Uniformity in the central royalty structure and legis-lative authority need deeper scrutiny as regional disparities in growth have not only risen over the decades, but have kept mineral-rich states in a state of des-peration, severely depressing their non-tax revenue base.In order to draw its relevance for the THFC, any decision on inclusion or weight-age to be assigned for “tax efforts” and “fis-cal discipline” must be with reference to the strength of the tax base of a state. The weak tax base is a reflection of the poor state of the manufacturing sector and industrial infrastructure. Decades of neglect of key infrastructure (railways, ports, roads, aviation and electricity, impor-tantly) have reduced the capacity of these states to take off with value added indus-trialisation. Instead, the opening of the economy since the early 1990s has led to a mad rush for unfettered exploitation of the state’s valuable mineral resources, with lit-tle in situ processing and cess revision. While competitive politics of federalism had taken away opportunities for early industrialisation in these states, the reforms process has suddenly exposed the states’ natural resources to be extracted without much scope for improving statal income.It is common knowledge that the poorer states are also poorer in terms of infra-structure – physical, social and economic. As some of the poorest states in India are mineral-rich (their dynamic competitive advantage), industrialisation requires mas-sive investment in various infrastructure. Additionally, even from the point of enhancing the social sectors, infrastructure promotion assumes urgency. As Padhi (2008: 9) observes,Creating a healthy ‘investment climate’ should therefore mean proper planning of public investments to minimise social and environ-mental costs of industrialisation. From this angle, the infrastructure gaps are likely to be more substantial, per unit cost of creation and maintenance of infrastructure relatively higher, and composition of public investments different from, as compared to a narrower view of public investments based on return to private investments in industrialisation. Pub-lic investments in infrastructure which help maximise social return are the best means of promoting and sustaining a healthy invest-ment climate. This would require significant public resources for financing balanced infra-structural development.In light of the aforesaid discussion, the THFC should consider a reduction in the weightage, for both tax effort and fiscal discipline taken together, to well below Table 5: Gainers and Losers in Transfers by Alternative Criterion, States/UTs vis-à-vis OrissaStates/UTs Poverty Incidence Per Capita Income (PCY) Rank Rank (POV) 2004-05 (average of 2002-05) Difference CombinedCombinedInvPCYPOVPCYAndhra Pradesh 34.05 177.69 56.28 16 13 3Assam 42.46 129.01 77.52 13 7 6Bihar 89.22 61.71 162.05 2 1 1Chhattisgarh 88.15 127.31 78.55 3 6 -3Delhi 31.68 411.71 24.29 18 23 -5Goa 29.74 404.41 24.73 20 22 -2Gujarat 36.21 207.11 48.28 15 16 -1Haryana 30.17 270.05 37.03 19 21 -2Himachal Pradesh 21.55 232.37 43.03 21 18 3Jammu and Kashmir 11.64 136.94 73.03 23 9 14Jharkhand 86.85 113.7487.92 4 5 -1Karnataka 53.88 179.81 55.61 8 14 -6Kerala 32.33 216.91 46.10 17 17 0Madhya Pradesh 82.54 109.83 91.05 5 4 1Maharashtra 66.16 240.51 41.58 7 19 -12Orissa 100.00 100.00 100.00 1 3 -2Punjab 18.10 255.11 39.20 22 20 2Rajasthan 47.63 134.78 74.19 11 8 3Sikkim 43.32 172.10 58.11 12 10 2Tamil Nadu 48.49 199.16 50.21 10 15 -5Tripura 40.73 177.06 56.48 14 12 2Uttar Pradesh 70.69 94.98 105.28 6 2 4West Bengal 53.23 173.30 57.70 9 11 -2All-India 59.27 Sources: Poverty Estimates for 2004-05, Press Information Bureau, Government of India, New Delhi, March 2007, at and State Analysis Service, Centre for Monitoring Indian Economy, at
COMMENTARYEconomic & Political Weekly EPW January 31, 200917R Uma Maheshwari ( is National Foundation for India Media Fellow 2008-09. Work for this article was supported by the fellowship.Accentuating the Social DivideR Uma MaheshwariDalit and tribal families in the West Godavari district of Andhra Pradesh, whose villages will be affected by the Polavaram dam project, face a peculiar problem. On receiving compensation for land given to the project, the non-tribal landlords have stopped cultivation, and work under the National Rural Employment Guarantee Scheme has been terminated because the land will shortly be submerged. Even for the contracts completed under the NREGS, there are discrepancies in the amount of work done and the wages the villagers have received.Muchika Rajamma and her daugh-ter-in-law Lakchamma, landless Koyas of Chegondapally village (Polavaram mandal, West Godavari dis-trict in Andhra Pradesh), approached the new employment programme in their village with great enthusiasm. A new 100-day work on a defunct check dam in their village was to begin. But within 10 days, theirenthusiasm turned to sheer frustra-tion.Rajamma says, “We did what we were told to do – dig up the soil. We worked for 10 days and at the end of the tenth day, got only Rs 300.” After a few days, however, the officials decided that works here should be stopped. All this happened in June 2008.The villagers, including Rajamma, had gathered at the Ramalayam/Rama temple to discuss the upadhi haami pathakam/vandal dinaala pani (the National Rural Employ-ment Guarantee Scheme-NREGS). Inciden-tally, ever since the Polavaram dam became the central issue for this village, the deity here has been witness to some of the most heated arguments about the project’s effect on the villagers. “I got Rs 200. I worked for seven days”, says Midiyam Saramma. “The gumasta (field assistant) told us they were ordered to stop the works since there is not enough money for it in this village. They told us not to come anymore.” They were fortu-nate that their village got at least 10 days worth of work. Pydipaka in the same mandal is a different story altogether. The computerised list of the NREGs programme in the mandal development officer’s (MDO) office at Polavaram shows “No work” against the Pydipaka village. Suresh, the computer operator, informs me, “it is going to be submerged; it was dif-ficult to convince the collector to get works done here.” According to the records for Pydipaka, 349 job cards were issued for 729 wage seekers (men – 384; women – 345), of which the scheduled castes (SCs) have 154 cards; scheduled tribes (STs) – 2; backward classes (BCs) – 159 and; others 54.Andu Peddaraju of Pydipaka says, The Assistant Project Officer (APO) Y Srinivas told us, “you are all going to leave, your village is going to drown; why do you need work?”. They gave us job cards but no work. We staged a dharna at the MDO’s office in Polavaram. The revenue divisional officer (RDO) and the project officer assured us they will solve our problems. But till date nobody has come. We have no land, no jobs. No SC here owns land. We used to work as labourers in the fields. Now we are just idle. Some of the villagers go to Jangareddygudem and Buttaigudem for work.It seems as if even an act that is sup-posed to guarantee livelihood to the poor, especially the socially excluded, stands no chance before the concept of “public good”. In the case of Chegondapally and Pydipaka, specifically, the Polavaram dam takes priority over guarantee of live-lihoods even before it is built. Polavaram mandal – the site of the spillway of the Polavaram dam – has shown perhaps the most pathetic record of NREGS program-mes by far. The East and West Godavari districts were among the newer districts to get the NREGs in April 2008. In Chegondapally, as in other villages in Polavaram, it was barely two months after 10%. The “Index of Infrastructure” and the “Poverty Ratio” need to be revived/modified to effectively address the issue of equity, especially as interstate disparity in growth has worsened during the post- reform period.ReferencesDas, Keshab (1993): “Planning and Regional Differen-tiation in India: Strategies and Practices”, Journal of Indian School of Political Economy, 5 (4).– (1997): “Politics of Industrial Location: Indian Federalism and Development Decisions”,Eco-nomic & Political Weekly, 32 (51). – (2007): “States Are Being Seriously Shortchanged Now”, Debate on “Should Royalties of Minerals Be Determined by the Centre or by the States Themselves?”,TheFinancial Express, New Delhi, 22 January. – (2008): “Orissa’s Memorandum to the Thirteenth Finance Commission: A Brief Contribution”, Paper presented at the State Level Seminar on State’s Memorandum to the Thirteenth Finance Com-mission, organised by the Finance Department, Government of Orissa and held at Swosti Plaza, Bhubaneswar, 17 October 2008 (mimeo, unpublished).Lenka, Jagannath and Minati Mallick (2008): “Finance Commission Awards: Horizontal Equityvs Regional Disparity” in R Sudarsana Rao (ed.), Issues and Recommendations of TwelfthFinance Commission (New Delhi: Serials Publications). Mishra, Aswini Kumar (2007): “Social Security in the Context of Extreme Poverty and Vulnerability in India”,The Indian Economic Journal, 55 (3).Padhi, Sakti (2008): “A Background Note on Gains in ‘Human Development’ and ‘Investment Climate’ of Orissa as Redistributive Factors”, Paper presented at the State Level Seminar on State’s Memorandum to the Thirteenth Finance Commission, organised by the Finance Department, Government of Orissa and held at Swosti Plaza, Bhubaneswar, 17 October (mimeo, unpublished).Rajaraman, Indira and Debdatta Majumdar (2005): “Equity and Consistency Properties of TFC Recommendations”,Economic & Political Weekly, 40 (31).Rao, M Govinda, Tapas Kumar Sen and Pratap R Jena (2008): “Issues before the Thirteenth Finance Commission”, Economic & Political Weekly, 43 (36).Shah, Amita, Saroj Kumar Nayak and Bipin Das (2006): “Ensuring Livelihood Entitlements in Forest-based Economies in Orissa: An Alternative Perspective”,Margin, 38 and 39/4 and 1.

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