ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Measuring Fiscal Performance of States

An alternative approach of measuring the fiscal discipline of states by preparing a composite index (Fiscal Performance Index) out of eight fiscal indicators is attempted in this paper. It is argued that although the Eleventh and Twelfth Finance Commissions fully recognised the importance of different fiscal parameters, like the composition of government expenditure, sources and pattern of government finances, the magnitude of debt, subsidies and interest burden, the measure of fiscal discipline, adopted by them is based on only one indicator. The Fiscal Self Reliance and Improvement Index constructed by the TFC that considers the 'change' in a single indicator is narrowly based, unstable and biased against the better fiscal performers. The suggested FPI, on the other hand, is multi-dimensional, more stable, just towards better performers and also useful for state level policy-making. The empirical analysis suggests the large inter-state variations in the level of FPI and almost continuous fiscal deterioration during the post-reform years.

Twelfth Finance Commission and Restructuring of State Government Debt: A Note

The Twelfth Finance Commission's proposed plan for restructuring the debt of state governments contains stringent conditions that probably violate the basic tenets of fiscal federalism. Macroeconomic norms dictated by global finance capital could not obviously be reconciled with the requirements of economic democracy.

Approach and Recommendations

The Twelfth Finance Commission has recommended a scheme of fiscal transfers that can serve the objectives of equity and efficiency within a framework of fiscal consolidation. The effort needed to achieve fiscal consolidation must be seen as the joint responsibility of the central and state governments. For achieving vertical and horizontal balance, consistent with the responsibilities of the two levels of governments in respect of providing public and merit goods and services, both the centre and the states need to raise the levels of revenues relative to their respective revenue bases, exercise restraint in undertaking unwarranted expenditure commitments and prioritise expenditures.

Balancing Stability, Equity and Efficiency

The prevailing fiscal environment is demanding and much was expected of the Twelfth Finance Commission's award in not only ensuring a fair share of resources between the centre and states and among the states inter se, but also in altering the incentive structure to promote fiscal discipline. Like its predecessors, the TFC did not make any drastic changes in total statutory transfers and worked around tax devolution and grants so that the centre's outgo was not substantially increased and equalisation was broadly similar to the past. Although the forecast of revenues and non-plan revenue expenditure has been seasoned with some norms, the incentive structure of the main recommendations remains unaltered. It is not certain whether they would be strong enough to induce the states to reduce revenue deficits.

Equity and Consistency Properties of TFC Recommendations

This paper examines three aspects of the Twelfth Finance Commission recommendations. First, it looks at the most urgent issue for states, the FRBM legislation which they must enact if they are to qualify for the interest rate reduction on debt owed to the centre. The required revenue deficit target of zero by 2008-09 is unambiguously clear but the fiscal deficit requirement is not. The parameter values underlying the fiscal deficit correction path could be valued by states very differently from those assigned in the TFC report. The second issue addressed in the paper is the complex and ambiguous set of conditionalities relating the debt write-offs in year t to the reduction in the revenue deficit in year (t-1) relative to (t-2). These conditionalities also carry a fiscal deficit cap which could be sharply inconsistent with a fiscal deficit correction path fully in conformity with that prescribed by the TFC. These issues are illustrated with simulations for a sample state. Finally, the paper examines the equity attributes of the tax devolution and non-tax grants prescribed by the TFC. The formula adopted for determining tax shares of states assigns a greater weightage to distribution-neutral factors, and so reverses the trend since the Sixth Finance Commission towards increasing weightage for redistributional factors. The non-tax grants do not show an inverse relationship with per capita GSDP. Together, these suggest that the TFC has chosen to move away from equity as a guiding principle for its statutory flows, but the report does not make plain why it has chosen to do so.

Debt Relief for States

The Twelfth Finance Commission has made significant recommendations on debt relief for states. The quantum of relief is substantial and the conditionalities - passage of a fiscal responsibility legislation and reduction of revenue deficits - are not unreasonable. However, single-minded pursuit of fiscal correction to get the benefit of debt relief can have disastrous implications for states where social and economic infrastructure investments have been insufficient. Some of them will have to impose heavy cuts on development expenditure to adhere to the tight schedule to bring down the revenue deficit to zero by 2008-09. A more rational approach may have been to allow them to follow more realistic adjustment paths over a longer period.

Some Analytics and Empirics of Fiscal Restructuring in India

The TFC?s focus on growth as a key element of its fiscal reform strategy is well taken. Also eminently sensible are its recommendations for performance budgeting; doing away with the distinction between Plan and non-Plan expenditure; and transparency including elimination of all hidden subsidies. However, the major weakness of the strategy consists of not dovetailing demand management policies in a developmental programme; ignoring the saving-generating impact of investment in an economy where rural and informal sectors are characterised by considerable underutilisation of resources even while the formal sector may not have much slack; treating education, health and other social sector expenditures as current; and absence of optimality considerations in respect of allocation of expenditures and of alternative modes of their financing, taking into account their short- and longer-term effects on growth, equity and government finances.

Symposium on Report of Twelfth Finance Commission

The Twelfth Finance Commission has broken new ground in several key areas and made recommendations which, if fully implemented, will have a far-reaching impact on the finances and functioning of government in the country at all levels. In order that the issues raised by the TFC report are debated in a wider forum, the EPW invited some of the leading scholars in the field to join in a symposium by contributing papers to this special issue. An overview of the papers and the issues is presented in this introductory article.

Malady of Continuing Fiscal Imbalance

The root causes of the endemic fiscal crisis, especially in the states, are to be found in the simultaneous pursuit of fiscal objectives and policies which are in themselves incompatible. Carry-overs from the central planning era, these policies proceed on the basis that finances can be managed without reference to incentives, financial capacity of sub-national governments or fiscal discipline. Fiscal responsibility cannot be planned from above; rather rules and conditions must be created so that it will have to be practised by states. Subject to this condition, state autonomy should not be affected by the system of central transfers.
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