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Debating the Thirteenth Finance Commission

Two comments and two responses on two of the papers published in the special issue of the recommendations of the Thirteenth Finance Commission (27 November 2010). (This discussion could be read alongside that published on 26 March 2011.)


A Response to Conundrums and Fundamentalisms Perceived in the THFC Report

Rathin Roy

with and without the fiscal discipline criterion does not take us very far. It would always be true that low income states would gain less than high income states if elements other than income distance, that were not perfectly correlated with income distance, were taken into account. The point is, therefore, is the average devolution progressive? As Table 8.4 in the THFC


Two comments and two responses on two of the papers published in the special issue of the recommendations of the Thirteenth Finance Commission (27 November 2010). (This discussion could be read alongside that published on 26 March 2011.)

Rathin Roy (rathin.roy@undp.org) is at the UNDP International Policy Centre for Inclusive Growth, Brasilia, Brazil. He served as economic advisor to the Thirteenth Finance Commission.

 

T

he articles in the EPW special issue (Vol XLV, No 48, 27 November 2010) on the 2009 Report of the Thirteenth Finance Commission (henceforth THFC) by Chakraborty (2010) and Rao (2010) raise several issues. Some are polemical, others have to do with the fundamental political economy of intergovernmental fiscal relations in India and therefore the context within which all finance commission reports are written. Engagement on these issues is very important. However, this would require a broader theoretical frame within which to engage in a discussion that transcends the THFC report. This response is limited to addressing a few substantive points raised by these authors with reference to the ThFC report (ThFC 2009).

 

Contradictory Formula?

Chakraborty (2010) makes an important point when he argues that the fiscal capacity and fiscal distance components can potentially contradict each other. This is true of all weighted formulae. If all the bases for the weights were correlated positively, then there would be no need for a weighted formula in the first place. One of the bases would suffice. This is well recognised. Thus, population and area have been in the formula in every commission report, and could well work in conflicting directions. For example, a state like Kerala gains with population, but loses with area. The reason why the THFC, like its predecessors, works with this limitation is precisely that differences in fiscal capacity are of a far more multidimensional nature across Indian states than in, say, Canada.

For this reason, the counterfactual exercise presented in Chakraborty (2010) assessing the award outcomes for states

april 23, 2011

report shows (THFC 2009, Volume 1: 123) the award results in an increase in devolution as a percentage of gross state domestic product (GSDP) to all states. The low income states all gain more than the high income states. It is semantically true that they could have gained even more with a different formula in which the weight accorded to factors other than those in perfect correlation with income distance is lower. But, if it is acknowledged that the horizontal distribution is justifiably affected by factors other than income distance then the semantics is not relevant in assessing the progressivity of the award.

There is, of course, a significant increase in the devolution to special category states for the very good reason that these states suffer from disabilities that transcend those faced by the other states and have, therefore, been treated on a basis that is separate from the other states by the ThFC. This is in line with, if different from, the approach of previous commissions which chose to address this difference solely through the grant route. The ThFC has, in fact, endeavoured to reduce the fiscal dependence of these states on the centre by taking account of their special circumstances in deciding the horizontal devolution, in addition to the grant instrument. In the case of Bihar, which Chakraborty goes to some length to single out as a case of unfair treatment, the same table shows that Bihar has the largest devolution as a share of GSDP in the ThFC award and is also the state with the largest increase in this share relative to the Twelfth Finance Commission.

Harsh Consolidation?

Chakraborty rightly points out that the ThFC’s road map for fiscal adjustment is not fundamentally different from that of the previous commission. This is something

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that the commission itself has sought as desirable, thus it “…takes up where FC-XII left off” (ThFC 2009, Vol 1: 25). The ThFC takes the view that the consolidation processes are disrupted by discontinuity in approach. This seems quite reasonable given the unprecedented success in fiscal consolidation in the 2005-10 period, whether due to the design proposed by the Twelfth Finance Commission, or totally exogenous circumstances.

Chakraborty also criticises the choice of the base year for fiscal adjustment – 2007-08 – which he describes as the “best year” for fiscal prudence. I agree. This was indeed the best year in India’s recent fiscal history – though not an outlier but a reflection of a steadily improving fiscal position over the latter half of the past decade. It appears quite reasonable, then, to take this as a benchmark for adjustment by states. The adjustment must, of course, be undertaken over a time path, given the increase in the counter recessionary spending obligations of the states, the impact of the recession on the tax effort in some states, and the need to adjust state government salaries to keep some measure of parity between emoluments of different levels of government as a result of the award of the Sixth Pay Commission in the years 2008-09 and 2009-10.1 Such a time path is indeed specified in the ThFC report.

The logic behind the time path is also clearly spelt out viz,

…the closing debt to GDP ratio is estimated to reach 82% in 2009-10 owing largely to the adverse macroeconomic circumstances in 2008-09…. In our view it should be possible to reduce the combined debt of Centre and States to around 68% of GDP by 2014-15. This target has been…based on our projections of the medium term macroeconomic situation during the award period and our assessment of the resource position of the Centre and the States over this horizon (ThFC 2010, Vol 1: 126).

Later in the same chapter, the commission opines:

it should be possible to make a small reduction in the aggregate debt GDP ratio of the states to 25% by 2014-15 especially if, as we recommend above, the Central government assumes responsibility for all borrowings due to unanticipated shocks and/or parameter changes of a global or national dimension. However the adjustment path will have to allow for temporary increases in revenue and fiscal deficits in 2008-09 and 2009-10 given the need for counter-recessionary expenditure

(ThFC, Vol 1: 137-38; my italics).

Thus, in setting the fiscal consolidation targets, the commission acknowledges that the consolidation can only start in 2010-11. In its approach, the overall consolidation required of the states relative to the centre is small, especially in view of two complementary policy actions: the recommendation that all future stabilisation-related expansionary spending obligations are assumed by the centre, and the increased devolution to the states.

The expectation is that the states would be allowed to borrow to invest, subject to a 3% deficit ceiling. Investment could exceed that ceiling, if greater fiscal prudence allowed elimination of a revenue deficit and the emergence of a revenue surplus across the award period. The choices the states would make in this regard are a matter for the states, subject to the overall maintenance of collective fiscal responsibility embodied in the application of the adjustment back to (at least) a zero revenue deficit position by 2011-12. By this time, the counter recessionary expenditure needs would have receded, and the economy is expected to be back on its growth path.

The logic here is simple: 2007-08 was not an outlier. It represented (as can be ascertained through a perusal of the record in the preceding three years) for most states, the benefits of an FRBM driven fiscal consolidation strategy that brought results. These results were critical to the overall health of the economy and contributed significantly to increasing the auto nomy and empowerment of the states in the domain of state finances. Hence the collectively small fiscal consolidation effort that the states need to make to return to such an empowered situation is what has been specified in the report, with enabling provisions regarding future expenditure liabilities as explained above, as well as an increase in devolution and grants. In the case of the states where the historic fiscal consolidation record had not been so virtuous, and for the special category states, separate provisions were made. There is therefore a logic to the proposals that one may of course disagree with. To label them as arbitrary is, to my thinking, not appropriate.2

Bihar Disadvantaged

The Bihar-Kerala comparison in Chakraborty (2010) is interesting, if odd. The counterfactual would have been for the commission to treat states that had not reaped the benefits of fiscal consolidation exactly the same way as states that did. The reason why West Bengal, Kerala and Punjab have been allowed a different time path is again simply to complete the process of fiscal consolidation that these states had failed to undertake or complete successfully (depending on your political take) in the preceding quinquennium. This is, to some extent, a political economy decision taken by the commission in its wisdom; the basis for the decision has been very clearly spelt out in Para 9.76 of Volume I of ThFC (2010). While one may disagree with the reasoning underlying this differential treatment, it is obvious that if the reasoning is followed then any of the above-mentioned states will have a more relaxed fiscal correction time path than the others.

Chakraborty (2010) argues that Bihar has been disadvantaged by the ThFC fiscal consolidation proposals. To argue this, the desired fiscal deficit GSDP ratio is taken as a “control total” for the 2010-15 period, and two scenarios are presented: One, “the business as usual” where the state would continue to grow its expenditures as if there were no fiscal constraint and, two, the consolidation scenario constrained by the need to secure a fiscal deficit of 3% of GSDP by 2014-15. However, due to the assumptions used to build both scenarios, everything grows at exactly the historic “trend” growth rate. In a situation where everything is “business as usual”, what this indicates is simply that Bihar cannot sustain its current path of capital expenditure expansion using its own resources, even with exemplary fiscal control, as the fiscal payback from such expansion would not be forthcoming in the time period in which the fiscal consolidation would take place. Note that this is not an empirical feature of Bihar’s development process but a consequence of the assumptions made in building the scenario.3

If the assumptions hold, the situation does not represent an axe on Bihar’s development efforts. It is a clear signal to the centre that Bihar’s desire to almost double

 

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its capital spending over the next five years will require some central attention, if this is not to jeopardise Bihar’s fiscal health and autonomy (even leaving aside the question of absorptive capacity and efficacy of such expenditure). If the assumptions do not hold, and there is an increase in growth or a diminution in the need to accelerate public spending on key public good provisioning within the time frame of the consolidation exercise, then Bihar’s ability to undertake capital spending will correspondingly rise in terms of the total spend, by an amount dependent on the impact on public saving and on GDP growth.

What Chakraborty’s scenario shows is the feasible (in terms of compliance with fiscal consolidation) capital expenditure increase – equivalent more or less to the increase in public saving – if there is no growth dividend from the historic increases in capital expenditure and development spending whatsoever across the 2010-15 period. Nothing more can be discerned from the analysis, even acknowledging that more public investment is always better than less! This is not so in the case of Kerala, and one would not expect it to be, for Kerala is a very different state, with different economic attributes and transitively different fiscal decision points (even absenting from the commission’s decision to accord it differential treatment the reasons for which are made explicit in the report). The comparison is therefore not very illuminating.

Govinda Rao’s paper raises some fundamental issues that are very pertinent to the raison d’être of the current intergovernmental fiscal arrangements. These have political economy dimensions which it would be presumptuous of me to address, but it is fair to point out that the ThFC position on these issues is very clearly spelt out in Chapter 3 of ThFC (2009).

States’ Share Underestimated

On the substantive side, Rao (2010) raises an important point: that the relative share of the states in total revenues may go down sharply due to the sizeable increase in resources from sources such as telecom revenues which are not part of the divisible pool. This is acknowledged in paragraph 4.18 in the review of central finances undertaken by the commission (ThFC 2009, Vol 1:46) and the commission has clearly taken an independent view on this subject. Thus, in the chapter where the projections of non-tax revenue are discussed the report states “As a proportion of GDP, the non-tax revenue is projected to increase from 2.01% in 2010-11 to 2.24% in 2014-15. MoF4 projected a decline in this ratio….to 1.7% during the same period. However, in view of the immense potential of sectors like telecommunications and petroleum, we feel that the MoF projection is an underestimation” (ThFC 2009, Vol 1: 82). The commission’s report also acknowledges that this is an unfinished task that needs to be addressed further in future years. It is argued that there is “…a need to rethink the basis of allocation of different revenue bases to different parts of the intergovernmental fiscal framework. An important example is the allocation of revenues arising form the ‘fiscal commons’. ….important examples of these would be profit petroleum, profit gas and revenue shares from spectrum” (ThFC 2009, Vol 1: 254-55).

Gap Filling

Rao (2010) also raises important concerns regarding “gap filling”. In this context it is important to note that there is a significant diminution in the post-devolution non-plan revenue deficit grant (NPRD) awarded by the ThFC. On the principle of NPRD, the ThFC’s analysis (which obviously satisfies this author), finds no moral hazard problem with the NPRD awards made by previous commissions, including no trend of increased inter-temporal recourse to this grant in the case of general category states (ThFC 2009, Vo1 1: 35).

In the ThFC’s award, both the volume and state-wise incidence of these grants declines sharply, not because any deliberate policy decision was made by the commission to do so but because this, as the report states, “..is to be expected given the structural improvements in the fiscal position of many States, including special category States” (ibid). Since the commission’s approach is to persist with incentivising the process of fiscal consolidation by states, as well as to ensure that all states gain proportionally and progressively in their share of devolution (measured as a percentage of GSDP) there is no case to be made for changing the approach to the question on NPRD grants while at the same time aiming for their expiry as a significant instrument of devolution.

In Conclusion

Both the papers engage in counterfactual exercises based on partial equilibrium


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fiscal responsibility the centre must assume for stabilisation efforts and a corresponding diminution in the states expenditure responsibility on this score; an increase in the devolution to local bodies; an absolute and (an income) progressive gain in the share of each and every state, in relation to its income base (GSDP); a significant reduction in the reliance on the NPRD instrument; an attempt to address the emerging issues of the day of central importance to the states including, importantly, the environment.

The commission’s award is arrived at through a process of holistic, not additive, reasoning. The process is evolutionary in approach, linked to the contemporary imperatives of India’s development challenge as discussed in some detail in the report (ThFC 2009: 22-23, 27, 30-38).5 The resulting recommendations are certainly not revolutionary. But, in my view, they are fit for the purpose.

Notes

are inter-jurisdictional spillovers in debt incidence and in payment capacities. The logic of Domar’s argument applies to the aggregate sustainability of economic growth at a national level. Treating states as sovereign actors in this circumstance is misleading. It is also for this very reason that the THFC argued that stabilisation expenditures and their fiscal consequences should be fully borne by the centre.

3 The development payback from such capital spending would generate a fiscal payback in a longer time frame. This is not an argument to abrogate the fiscal rules, but to seek resources that would allow a temporary increase in fiscal spending higher than that the maximum the State can undertake consistent with fiscal stability. See Roy, Heuty and Letouze (2009) for a fuller discussion of these issues.

4 Ministry of Finance, Government of India in its memorandum to the THFC.

5 It is desirable that the legitimacy of this approach be discussed and debated for future policymaking but so far there has been no commentary on this important dimension of the THFC’s work.

References

Chakraborty, Pinaki (2010): “Deficit Fundamentalism vs Fiscal Federalism: Implications of 13th Finance Commission’s Recommendations”, Economic & Political Weekly, XLV (48), pp 56-63.

Domar, E D (1944): “The ‘Burden of Debt’ and the National Income”, The American Economic Review, (4), pp 798-827.

Rao, M Govinda (2010): “The 13th Finance Commis

reasoning to establish how states or groups of states have “lost out” as a consequence of one or other decision of the commission. This approach treats the centre and the states as permanently locked in an adversarial relationship in which the battles lost and won are the partial equilibrium gains and losses to either side. In my view, in a situation where rapid economic growth and a recent and unprecedented history of successful fiscal consolidation has been an integral feature of the fiscal landscape, more attention needs to be paid to the gains that all stakeholders (the centre, states, local bodies and the non-state development actors) can reap from persisting with these efforts.

Has the ThFC report identified the positive sum gains? From the perspective of the states, it appears to me that it has done so in ample measure. In the final instance what each state gets is a function of the total award of a finance commission, not of its elements. What matters is this outcome which can, and should, be judged. From the states’ perspective, the ThFC award delivers the following: an increase in the devolution to the states; a more stringent stipulation with respect to the fiscal reforms the centre needs to make relative to the states; an increase in the

1 The commission has rightly recommended an end to the sclerotic process of adjusting central and state government salaries with huge retrospective elements due to adjustment lags, causing fiscal shocks to both levels (THFC 2009, Vol 1: 136-37).

2 Chakraborty’s (2010) application of Domar’s (1944) logic to subnational units is, in my view, incorrect. Subnational units do not bear sovereign obligations on the debts they incur. There




Defending the Indefensible

M Govinda Rao

sion’s Report: Conundrum in Conditionalities”, Economic & Political Weekly, XLV (48), pp 46-55.

Roy, Rathin, Antoine Heuty and Emmanuel Letouze (2009): “Fiscal Space for What? Analytical Issues from a Human Development Perspective” in Rathin Roy and Antoine Heuty (ed.), Fiscal Space (New York: United Nations Development Programme and London: Earthscan).

THFC (2010): Report of the Thirteenth Finance Commission (2010-2015), New Delhi.

Roy asserts that there is no moral hazard on the basis of the consideration that tax devolution covers the difference between projected revenues and non-plan revenue expenditures and there is no

 

O

ne must sympathise with Rathin Roy who has taken up the task of defending the approach adopted by the Thirteenth Finance Commission. Not surprisingly, he hesitantly asserts that the “gap-filling” approach which the commission has continued to adopt does not entail the moral hazard problem since there has been a significant diminution in the post-devolution non-plan revenue deficit grant. Not surprisingly, this is a poor defence of the commission’s approach to transfers which has inherent shortcomings.

 

The shortcomings of the approach relate to both equity and incentives in the transfer system. I had elsewhere summarised the shortcomings as (i) tyranny of the base year; and (ii) fiscal dentistry. By taking the actual revenues and nonplan revenue expenditures as the base and making their projections to determine the gaps, commissions after commissions have failed to offset the fiscal disabilities of the states arising from shortfalls in revenue capacity and high unit cost of providing public services. Taking actual revenues and expenditures has serious perverse incentives as shown in an important conceptual paper on fiscal equalisation by Richard Musgrave way back in 1962.

Economic & Political Weekly

 

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residual gap in respect of all general category states. The point is that the structure of incentives is not static; it is like repeated games. The expectation is that the gaps will be covered and the larger the gaps, more is the state likely to get. In fact, stung by the “gap-filling” criticism, the Seventh Finance Commission (with the heavy influence of its inimitable member, Raj Krishna) increased the share of union excise duties to the states from 20% to 40%. This covered the gaps of virtually all general category states (except Orissa). Of course, the revenue deficit of the centre emerged from 1979-80, the first year of the Seventh Commission’s award, but more importantly, by the mid-1980s, the revenue deficits emerged in the states again.

Unfortunately, robust empirical studies on the impact of the “gap-filling” approach on the finances of the states are not available mainly due to the difficulties in modelling the behaviour. First, the responses of the states to the approach would be vastly different and, second, it is difficult to model it with appropriate lags. That, however, should not be taken to assume that there are no moral hazards because the design of the system has inherent perverse incentives. Nor is there any need to pretend that disabilities arising from a shortfall in taxable capacity are taken account of simply by substituting distance from highest per capita state domestic product with the


Education Sector Grants: Misplaced Criticism

Deepa Sankar

so-called “fiscal capacity” distance as argued in my paper.

M Govinda Rao (mgr@nipfp.org.in) is Director, National Institute of Public Finance and Policy.

Reference

Musgrave, Richard (1962): “Approaches to a Fiscal Theory of Political Federalism” in NBER, Public Finance: Needs, Sources and Utilisation, Princeton University Press.

the initial stages took time to develop), by the time of Eleventh Plan, states were still in their physical input expansion phase and hence the annual work plan and budgets of states/districts (and expenditures) started increasing (see Graph 1, p 81). Realising that the states were sharing on a

 

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wo articles in the special issue (27 November 2010) reviewed the provision of education sector grants by the Thirteenth Finance Commission (THFC): “Recommendations Relating to Grants-in-Aid” by Narayan Valluri (pp 85-91) and “Deficit Fundamentalism vs Fiscal Federalism: Implications of 13th Finance Commission’s Recommendations” (Pinaki Chakraborty: 56-63).

 

Valluri in his article took cognisance of the fact that “SSA (Sarva Shiksha Abhiyan) took a holistic view of expenditure needs and gaps, THFC adopted its norms with some modification”. The author also looked at the method in which THFC provided grants for SSA, and argued that “in spite of the government’s pledge to raise public spending on education to at least 6% of GDP, … it would be carping to question grants-in-aid designed to provide an additionality of funds to states to elementary education”. While Valluri approached the analysis of education sector grants was with great sensitivity and understanding of education sector needs, the article by Chakraborty seems to be more opinionated. This note is in response to the concerns raised by Chakraborty.

In the article, Section 4 is titled “Sector and State Specific Grants” and the author has focused only on education sector grants (which forms just 7.5% of all the grants-in-aid) for review and has not looked at other sectors. While it is interesting that the education sector has got the sole attention, it is unfortunate that the review is only partially informed, as the review has not taken cognisance of the funding mechanisms of the SSA, the flagship centrally-sponsored scheme (CSS) for education and now, the primary vehicle for implementing Right to Education (RTE).

Chakraborty criticises the THFC’s estimation of an at least 8% increase in education expenditure during the THFC period by citing the trend growth rates of states’ elementary education expenditure during 2004-05 to 2007-08, which according to the author’s estimates, stand at 14.6%. The author may benefit by looking at the expenditure patterns of states since 2002 in a disaggregated manner. The increase in the state expenditures on elementary education is on account of their allocations of state share for SSA. During the Tenth Five-Year Plan period, the SSA allocations were shared between the centre and states at 75:25. As per the original design, during the Eleventh Five-Year Plan, SSA sharing patterns were expected to be 50:50 between the centre and the states. This was with the anticipation that the major capital expenditures required under SSA (in terms of physical expansion, civil works and maintenance) would be saturated by the end of the Tenth Plan, and with the focus on soft components like quality, the fund requirements will be lesser than during a high civil works/infrastructure intensive expansion phase and a 50:50 sharing of SSA would be still manageable.

However, with an initial slow start (as human resources and capacity building at

april 23, 2011

  • 50:50 basis the SSA outlays at a time when they were expanding their plans and budgets, the Planning Commission decided to revise the centre: state sharing norms for SSA outlays under the Eleventh Plan, with the shares of states in SSA outlays increasing to 35% by 2007-08 and 2008-09, 40% by 2009-10, 45% by 2010-11 and
  • 50:50 by 2011-12. The state-wise growth in elementary education expenditure should be viewed in this context.
  • By 2010, most of states/districts have nearly saturated their physical requirements/infrastructure needs as specified in the SSA Framework. As a result, the expectation was that the requirements of physical expansion and infrastructure provision would become stagnant or declining and SSA would then mostly focus on the softer aspects of the programme, mainly quality-related interventions. The projections of an only 8% increase annually of the state expenditures were on account of these assumptions and the projections were reasonably applicable to most of the states, including those whose requirements for SSA were less on account of their education provision development levels.

    The argument that “the design of the grant is such that most of the states would still be eligible for it if they bring down their own expenditure from the current level” seems naïve and contradictory, given the fact that what THFC prescribes/ allows is not a reduction in expenditure, but an increase in expenditure levels from the previous year, at least by 8%.

    vol xlvi no 17

    Graph 1: SSA AWP&B, Funds Released and Expenditures

    (Rs in crore) 30,000

    24,000

    18,000

    12,000

    6,000

    0

    Source: MHRD.

    Chakraborty has also compared education grants provided by the Twelfth Finance Commission (TWFC) and THFC and commented that

    Coming to the quantum of grants provided, the grant for elementary education proposed by the THFC is much higher than what was proposed by the TWFC, which was pegged at Rs 10,172 crore.

    This comparison is made without looking into the changes and details of education sector priorities and context. Let us first compare the TWFC and THFC in terms of grants allocated to education sector: The TWFC’s Rs 10,000 crore was (a) for only eight states; (b) it was supposed to cover all of the education sector; (c) TWFC’s education grants were given when SSA was still in its preliminary stage; and (d) TWFC hence did not have the benefit of understanding how much resources would come from the CSS to states, and hence assuming the entire resources needed for universal elementary education (UEE) as that from state kitty. In the case of the THFC, the situation was different. SSA has been under implementation for nearly eight to nine years; the states had a clear understanding of the requirements in terms of SSA funds; and it was well established that the central share would enable the states to meet at least 50% of the requirements.

    172 1306 3057 6598 10002 12853 15785 19344 539 2302 4943 7873 11478 17023 19701 23679 1117 3659 8570 11034 14290 20868 21364 24268 Expenditure Fund available AWP&B

    2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

    Similarly, Chakraborty argues “The full equalisation requirement as per the TWFC norm worked out to be Rs 67,811 crore for its award period. Thus, THFC grant at Rs 24,068 crore is only around 36% of the full equalisation requirement as per even the TWFC norm, that too in nominal terms”. The comparison that THFC grants forms only 36% of what was required to fully equalise the requirements of even the TWFC in nominal terms is like comparing apples and oranges. TWFC’s estimations were for the whole education sector, whereas THFC’s grants are specific for elementary education sector. The author’s argument that “the TWFC grant was also better in terms of its design and helped the states to augment their expenditure on education” is misplaced as there is no evidence to suggest that the TWFC grants have facilitated states to augment their resource allocations for education sector. In fact, what helped the states to increase their resources for elementary education is the conditions or sharing requirements of SSA.

    Lack of Understanding

    The author’s argument that the THFC’s need based grants for SSA are “ad hoc and arbitrary” seems to be emerging from a lack of understanding of the financing of education sector in the country, especially the way the SSA operates. It is important to note that education sector investment/

    REFLECTIONS ON EMPIRE
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    Imperial Democracies, Militarised Zones, Feminist Engagements – Chandra Talpade Mohanty
    Rethinking News Agencies, National Development and Information Imperialism – Oliver Boyd-Barrett
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    expenditure cannot be happening through fragmented projects/funding mechanisms. In fact, realising the need to have an integrated and holistic approach for developing the education sector strategy, the MHRD brought its different projects aimed at different aspects of elementary education under the umbrella project of the SSA. The SSA is also now designated as the vehicle for implementing the Right to Education Act. When the SSA is one of the most comprehensive education programmes in the world today, the author’s comment that “Instead of depending on the SSA norms and justifying its grant on the grounds that the contribution of states for the SSA will go up, the THFC should have revised its own norms for complete equalisation and given the grants required by the states” appears to be very naïve and counter-intuitive.

    With the RTE, no state can go back on its commitment to provide all that is required under revised SSA norms and hence the doubts about whether states will provide their contribution or not is misplaced. Besides, the finance commission does not have any specific norms for supporting education, and the argument that “THFC should have revised its own norms” for funding education sector grants does not hold ground. The author’s understanding that the current provision under THFC is “partial equalisation” is also misplaced. This is because the following reasons:

  • (a) the requirements of elementary education under SSA for the five-year period from 2012-17 was estimated based on sound evidence and supporting norms;
  • (b) while the central share was expected to become 50% and states were already providing 35% when the THFC was making its estimations, the gap which was required to be bridged was to the extent of 15% of SSA outlays; and (c) by providing 15% of the total outlays of SSA to the states, the THFC’s effort was to ensure filling the gaps and ensuring full equalisation (means every states gets what it requires to fill its gaps). Since the central share of the SSA meets the non-state and non-THFC shares, it is preposterous on the part of the author to argue that the THFC

  • Response to Rathin Roy and Deepa Sankar

    Pinaki Chakraborty

    should have provided all funds required for “full equalisation”.

    It may be also noted that THFC awards were estimated before the RTE came into existence in April 2010. The revised allocations for SSA for implementing RTE are estimated to be Rs 2.31 lakh crore for the next five years. Taking into considerations the revised norms of SSA (as SSA is now the designated vehicle to implement the RTE), and its financial implications, the centre: state shares have been revised, with centre now will provide a 65% share, 25% will be contributed by states, and the Rs 24,068 crore allocated under THFC (as 15% of the estimates using the previous SSA norms) will now contribute the remaining 10% of the requirements, thus ensuring adequate funds. Clearly the THFC grants for elementary education has helped the transition from SSA to RTE and enabled RTE to be notified from 1 April 2011.

    Deepa Sankar (dsankar@worldbank.org) is with South Asia Education, World Bank, New Delhi.

    large volume of state-specific grants to the tune of Rs 27,945 crore, in order to bring in an incentive based fiscal discipline. A separate grant for fiscal discipline further strengthens my argument that when the commission has set aside a large sum of grants for fiscal consolida

     

    I

    am grateful to Rathin Roy and Deepa Sankar for their responses to my paper “Deficit Fundamentalism vs Fiscal Federalism: Implications of 13th Finance Commission’s Recommendations” (EPW, 27 November 2010, 45(48): 56-63). My rejoinder below is structured according to the section headings in the case of Roy, and separately on Sankar’s observation.

     

    Contradictory Formula?

    There can be a conflict between different indicators in case of use of weighted formula for allocation of resources between states. However, if the primary objective of the transfer system is to achieve horizontal fiscal equity, one has to be careful on the choice of indicators so that such contradictions are minimised. The example given by Roy that “population” and “area” could well work in conflicting directions is true. But one has to distinguish between neutral indicators of “need” and indicators reflecting “needs” based on equity and efficiency principles.

    By using neutral indicators like “area” and “population” (and with relatively low weights) such contradictions are much less compared to equity and efficiencybased criteria like “fiscal capacity distance” and “index of fiscal discipline” which occupy 65% of the total weight in the Thirteenth Finance Commission (THFC) formula.

    The fact of the matter is that the THFC has gone overboard on efficiency concerns, which has seriously compromised equity. The host of efficiency concerns that have dominated the THFC recommendations are reflected in the plethora of conditional grants handed out, including a

    april 23, 2011

    tion to ensure fiscal discipline, why try to achieve the same objective again through the devolution formula? My paper acknowledges the fact that fiscal capacity distance as estimated by the commission is an interesting innovation and taking the group average tax ratio instead of the actual tax ratio to estimate the fiscal distance gap imply that it does not reward the states for non-performance. This, in turn, means that the fiscal distance criteria itself, to an extent, takes care of both the equity and efficiency concerns.

    Roy justified the progressivity outcome of the horizontal distribution formula since the recommended tax devolution to GSDP ratio has increased for all the states. However, progressivity needs to be judged against the fiscal capacity, and not by the sheer volume of transfers. In this context justifying that Bihar has not been unfairly

    vol xlvi no 17

    treated is a distortion of the argument made in the paper. The paper does not talk about fairness in the sense discussed by Roy. It talks about fairness in terms of objectivity of transfers. It is also to be remembered that a large devolution as a share of GSDP for Bihar is not a reflection of progressivity. In terms of the share of tax devolution, Bihar’s share in total devolution consistently declined in the award period of the last three finance commissions including the THFC (Chakraborty 2010a). To understand progressivity, the simple example would be Bihar’s per capita development spending, which is currently only 55% of the all state average development spending. This only shows that despite apparent progressivity in the transfer design, the volume of transfers have just not been sufficient enough for equalisation. But one also has to acknowledge the difficulty in quantifying that equalisation amount and the finance commission alone cannot be blamed for that. Much of the problems arise due to the fragmented transfer system as has evolved over the years and also the complex horizontal distribution formula adopted by successive finance commissions.

    Harsh Consolidation?

    The fiscal consolidation road map of the THFC is definitely harsh because of two reasons: (1) the state-specific fiscal adjustment path that has been laid down;

    (2) fixation of the debt-GSDP ratio, and the adherence to (1) and (2) to be eligible to get some of the THFC’s conditional grants. The fundamental point I have made in the paper is very simple and is conveniently missed by Roy. It is that if the aim is to achieve fiscal sustainability one must have an objective assessment of the state-specific sustainable levels of deficits rather than a rigid “one size fits all” numerical target of 3% of GDP. Once that is done, fix the indicative debt-to-GSDP r atio based on that estimated sustainable deficit. We cannot start from the outcome and work backward to justify the outcome! If state-specific sustainable deficit targets had been estimated by the commission, objectivity would have been maintained be it in the state-specific fiscal adjustment path or the overall fiscal consolidation proposed by the commission.

    The example of the projected fiscal profile of Bihar and Kerala in my paper only brings out this simple point.

    According to Roy 2007-08 was not an outlier in terms of fiscal prudence. According to him “It represented (as can be ascertained through a perusal of the record in the preceding three years) for most states, the benefits of an FRBM driven fiscal consolidation strategy that brought results”. However, Roy’s argument is not supported by empirical evidence. The commission’s own analysis of fiscal imbalance shows that all states’ fiscal deficit declined from 4.24% in 2004-05 to 1.93% in 2007-08 and this is remarkably low if one compares the trends in states’ fiscal deficit for the past 20 years. Thus, taking 2007-08 as the base year for the path of fiscal consolidation is inherently harsh for the states. Also, with the global financial crisis, the state-level deficit definitely increased and the THFC giving only one year of adjustment for them to return to the pre-crisis level cannot be a meaningful acknowledgement of the macroeconomic downturn. Also, the assertion that improvement in fiscal balance is due to the FRBM, as commented by Roy, can be questioned. As estimated in Chakraborty (2008) much of the improvement in the state-level fiscal situation up to 2007-08 was primarily due to the improvement in revenue performance at the central level, the performance of VAT at the state level and the softening of the interest rate. If one assumes that much of the fiscal improvement is due to the favourable macroeconomic environment and the consequent revenue performance up to 2007-08, one is not really certain how rigid fiscal consolidation target could be proposed by the commission when the impact of the global financial crisis was looming large on the Indian economy. Thanks to the post-crisis increase in economic growth, revenue did not suffer as much and states have been able to cope again with a generous 6th Central Pay Commission award that was implemented in 2008-09 in many states.

    In an adverse macroeconomic situation, if states had to follow the revised road map for fiscal consolidation, then surely it would have been at the cost of development spending.

    Bihar Disadvantaged?

    It is true that most projection exercises do not take us far. But, as mentioned in the paper, the Bihar and Kerala comparison was only to show the futility of an exercise like preparing a revised road map for fiscal consolidation. The fiscal scenarios developed for Bihar and Kerala only show that the premise under which the THFC gave a less rigid target of deficit reduction for Kerala was not required because Kerala’s fiscal situation has improved since 2007-08, while a stricter norm for Bihar has the potential to reduce the development spending in the state when it is on the path to recovery. This would not have happened if state-specific sustainable deficits were the targets for fiscal consolidation.

    Roy also criticised the fiscal adjustment path of Bihar and Kerala as both the outcomes were sensitive to the kind of assump tions made to construct these paths. Any projection exercise would have the same limitations, including those made by the THFC. The only strength of the projection made in the paper is that there is no prescriptive norm based projection as was in the case of the finance commission projections, be it of the deficit or the debt-to-GSDP ratio. The paths derived in the paper show what the likely fiscal situation will be if the past trend continues, and are thus reliable for the purpose of comparison with imputed targets of deficits and debt as imposed by the THFC.

    Sector-Specific Grants for Education

    Now let me turn to the other comment by Deepa Sankar on the paper relating to state-specific grants for education. I must admit that I am not an expert on the Sarva Shiksha Abhiyan (SSA) and much of my “naïve” comments may be because of my ignorance. However, I remain puzzled and with my limited knowledge I will suggest answers to some of the queries raised in the note.

    Sankar argues that the growth of elementary education expenditure is going to decline in the coming years as much of the major investment required for elementary education has already been made through SSA. Also, according to Sankar, recent growth in elementary education by states, as estimated in (Chakraborty 2010b) at 14.6%,

     

    EPW

    april 23, 2011 vol xlvi no 17

     

    needs to be viewed against the increase in the states’ share of SSA and I quote

    Realising that a 50:50 sharing of SSA outlays when the states were expanding their plans and budgets, Planning Commission decided to revise the centre: state sharing norms for SSA outlays under the 11th Five-Year Plan, with the shares of states in SSA outlays increasing to 35% by 2007-08 and 2008-09, 40% by 2009-10, 45% by 2010-11 and 50:50 by 2011-12. The state-wise growth in elementary education expenditure should be viewed in this context.

    Even if one accepts the argument that the growth rate of expenditure has been high in the past due to the increase in the states’ enhanced share of SSA, this should be reflected in the growth from 2007-08 onwards and not before that. The growth that I have reported at 14.6% is for the period from 2004-05 to 2007-08. If we exclude the first year of enhanced share of state spending in SSA, i e, 2007-08, the growth of elementary education expenditure turns out to be even higher at 15.57%. If we look at the state-level elementary education expenditure growth for the period from 1990-91 to 1999-2000, when there was no SSA (except for the District Primary Education Programme in selected districts), the growth rate was 14.55%. So Sankar’s argument that the high growth of state elementary education expenditure in recent year is due to in-

    I am appalled by this logic. I think it is critically important to understand the relative importance of SSA contribution by the states’ in their total elementary education spending. As evident from Table 1, the states’ SSA contribution in total elementary education spending is not more than 10-11% of their total spending in this sector, except for states like Bihar and Jharkhand where it is more than 20%. Thus, if one starts thinking that SSA is the only driver/provider of elementary education, it would be grossly unfair to the states. Given the fact that SSA hardly covers salary expenditure, I am not too sure whether expenditure growth would come down as the capital spending has already been done for creating physical infrastructure. In fact, the reverse seems quite likely, with a high teachers’ salary-driven growth in expenditure in the future. In this context, it is impossible to understand how there will be an augmentation of expenditure if it is pegged at a lower level of growth rate than what is observed in the past, anticipating that the growth will come down as much of the investment has already been made and would provide fiscal space for spending.

    Table 1: States’ Contribution to SSA in Total State Spending in Elementary Education (in %)

    2005-06 2007-08 2008-09
    Andhra Pradesh 5.22 5.11 6.26
    Bihar 4.74 22.57 22.43
    Chhattisgarh 12.99 19.81 17.05

    with RTE infrastructure and PTR norms alone is close to Rs 50,000 crore. This is devoid of the mid day meal, equipment and other training costs. Infrastructure and teacher costs are undoubtedly a large proportion of the total cost and these estimates therefore provide a sense of the nature and magnitude of expenditure that the RTE would entail.

    In fact, it is obvious that with the RTE, the states’ expenditure commitment is going to go up and the states need to create additional fiscal space to cover this additionality in spending. Sankar’s own observation in the note says that although the additional grants provided by the THFC to cover 15% of the additional centrally-sponsored scheme (CSS) contribution under SSA would now be covering only 10% of it.

    Finally, without diluting the role of the SSA, when the state spending is significant in financing elementary education, I would be curious to know: can equalisation be done by adopting the norm of a CSS and providing additional spending in anticipation of the states’ share of contribution going up in future without correcting for fiscal inequality across states. If this logic is stretched further, such an approach can be extended to many other CSS in the name of equalisation disregarding state spending. This is in this context that the equalisation norm prescribed by the Twelfth Finance Commission was different and took a holistic view of the differential fiscal capacity

    creased SSA contribution by the states is Goa 8.36 5.51 5.01 across states and tried doing a partial

    totally misplaced. It is important to look at the financing of elementary education in its totality, giving due acknowledgement to the relative roles of the centre and the states and their financing responsibilities, and not just through the lens of the SSA, however important it may be.

    Sankar has further argued: Gujarat 3.70 4.32 4.67 equalisation of health and education for

    Haryana 3.63 6.44 6.10 selected states, although there is always Jharkhand 9.45 26.87 20.91

    scope for debate on the norms prescribed

    Karnataka 5.22 6.99 7.09

    by them. But that is a different issue.

    Kerala 2.62 2.58 2.84 Madhya Pradesh 18.11 15.82 15.21 Maharashtra 3.04 3.26 4.77 Pinaki Chakraborty (pinaki@nipfp.org.in) is Orissa 7.31 17.57 10.36 at the National Institute of Public Finance and

    Policy, New Delhi.

    Punjab 9.14 8.02 9.52

    By 2010, most of the states/districts have nearly saturated their physical requirements/ infrastructure needs as specified in the SSA Framework. As a result if the expectation was that the requirements of physical expansion and infrastructure provision would become stagnant or declining and SSA then would mostly focus on softer aspects of the programme, mainly quality related interventions. The projections of only 8% increase annually of the state expenditures were on account of these assumptions and the projections were reasonably applicable to most of the states, including those whose requirements for SSA were less on account of their education provision development levels.

    Rajasthan 6.19 12.69 14.01

    Tamil Nadu 5.88 6.83 6.61
    Uttar Pradesh 11.54 14.79 13.97
    West Bengal 5.44 17.31 11.08
    Total 6.90 11.46 10.65

    It is probably also not right to assume that the physical infrastructure need has already been met. In fact in the context of the Right to Education (RTE) Act, there may be unmet infrastructure need to be covered in the medium term. According to the latest PAISA report (2010)

    The cost estimate for existing and potential schools in rural India to become compliant

    april 23, 2011

    References

    Chakraborty, Pinaki (2008): “Budget Rules, Fiscal Consolidation and Government Spending: Implications for Federal Transfers”, Presented in a Seminar “Issues Before the Thirteenth Finance Commission” organised by National Institute of Public Finance and Policy, 23-24 May.

  • (2010a): “Implications of Finance Commission Transfers to Low Income States: A Study of Bihar”, International Growth Centre, London School of Economics, UK.
  • (2010b): “Deficit Fundamentalism vs Fiscal Federalism: Implications of 13th Finance Commission’s Recommendations”, Economic & Political Weekly, 45(48), 56-63.
  • PAISA report (2010): http://www.accountabilityindia. in/sites/default/files/state-report-cards/ paisa2010report.pdf

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