There is a furore over the terms of reference of the 15th Finance Commission that has directed it to consider the 2011 population figures instead of hitherto used 1971 population data to work out inter-state shares in the divisible pool. The southern states, which have performed better on the population front than the northern states such as UP, MP and Rajasthan, consider themselves paying the price for controlling population and providing better health and education facilities to their people.
Earlier, the 14th FC had raised the states’ share in the divisible pool of taxes to 42 per cent from the previous 32 per cent. While accepting the recommendations of the 14th FC, Prime Minister Narendra Modi had said that although this would mean less money at the Centre’s disposal, yet his government had decided to strengthen the cooperative federalism. Apparently, the ToR for the 15th FC suggests otherwise.
The Centre has also urged the Finance Commission to finalise its tax-devolution formula after factoring in the impact on the Union’s fiscal situation. Taken together with its need for resources for essential spending in areas such as defence, security, infrastructure, climate change, etc and uncertainties in GST receipts, the Centre seems to be seeking a rollback of the 42 per cent share for states. But, any reduction from 42 per cent share could dent the states’ faith in the cooperative federalism.
However, the rollout of the Goods and Services Tax (GST), which marks a new chapter in cooperative federalism, makes the job of the 15th FC more complex. The Centre is committed to compensate states for any revenue loss arising out of the GST implementation for five years, thus covering nearly half the period for which the Commission is supposed to make recommendations.
Besides, making recommendations relating to the division of net proceeds of taxes between the Centre and the states, the Commission has been assigned wide-ranging terms of reference, including deficit, current status of finance, debt levels, fiscal efforts of the Union and the states. It will also recommend fiscal consolidation road map for sound fiscal management. Its mandate also includes formulating performance-linked incentives for states on a range of desirable outcomes such as attaining a replacement rate in population growth, deepening the GST net and improving the ease of doing business. Thus, the terms of reference of the 15th FC are so complex that it will be a great challenge for the Commission, especially when one has to reward a state for showing “control or lack of it in incurring expenditure on populist measures”.
It may be recalled that there is an in-built constitutional bias in favour of the Union government as far as financial resources are concerned. And, over the period, when a single political party was in power both in the Centre and states, the Union government has further strengthened its position and encroached upon the rights of states. It is another thing that with the latest Constitutional Amendment (Eightieth Amendment Act, 2000), the distinction between shareable and non-shareable taxes has become irrelevant. However, when the Constitution was amended to distribute the total central tax proceeds, the word ‘gross’, as recommended by the Tenth Finance Commission, was substituted by ‘net’, thereby the share of states from the divisible pool of taxes was reduced permanently. Although the then Punjab Finance Minister, Captain Kanwaljit Singh, objected to this manoeuvrability, the Central government promised to compensate the states. Thus the total expenditure on tax collection stands deducted from the shareable taxes.
Even when the 14th FC recommended hiking the share of states to 42 per cent of tax revenue, the Union government made substantial cuts in expenditure relating to schemes benefitting states. Then, the proceeds from surcharges, cesses and non-taxable sources are also kept out of the shareable pool. From the current fiscal, the Centre has levied a non-shareable new road cess on petrol products in lieu of basic excise duty and additional excise duty. Earlier in 2016 also, the Finance Minister replaced wealth tax with additional cess on income tax.
Whatever the recommendations of the 15th FC may be, the Commission must keep up the spirit of cooperative federalism, which has just been created by the implementation of GST. In fact, states’ cooperation is the pre-requisite to move towards implementing economic reforms, whether it is the area of tax reforms, labour laws, land acquisition laws, education, health, social security, etc. Even the latest ‘Ayushman Bharat’ scheme of the Centre is seen by some states as subsuming their own health insurance schemes.
Lastly, the 15th FC should also rejuvenate the true form of cooperative and participatory federalism, which will be realised when power flows to the people at the grassroots level. Twenty five years back, Rajiv Gandhi had implemented 73rd and 74th Constitutional Amendments, whereby 29 and 18 functions were transferred to panchayati raj institutions and urban local bodies, respectively. In this context, the Finance Commissions, both Union and states’, are playing useful role. In order to incentivise the states to move faster towards decentralised form of government, the 13th Finance Commission (2010-15) was the pioneer to divide the amount of total grants into two categories: basic grants and performance grants. The 13th Finance Commission advocated that “given the increasing income of state governments from royalties, they should share a portion of this with those local bodies in whose jurisdiction such income arises”. The 14th Finance Commission has also provided performance grants to address issues such as making available reliable data on local bodies’ receipts and expenditure, and bringing improvement in their own resources. Now, it is the job of the 15th FC to carry forward the task of strengthening decentralisation form of governance in the country.
To conclude, India needs to promote cooperative and participatory federalism right up to the grassroots. States and local self-governments will have to be involved in the process of development. Since the total revenue of the Union government is much more than that of all the states put together, financial considerations should not come in the way of pushing economic reforms and promoting a true form of federalism in the country. The 15th FC should see that better performing states do not suffer. But poorer states need to be helped to bridge the inter-state gap in the provision of basic services to all citizens. The poor-performing states need to be incentivised for fiscal prudence and quality expenditure.
— The writer is a former Professor and UGC Emeritus Fellow at the Department of Economics, Punjabi University, Patiala
The needless controversy
A needless controversy is sought to be created that the Terms of Reference (ToR) of the 15th Finance Commission are loaded against any particular region of the country. Nothing could be further from the truth.
The share in central taxes is allocated to the states based on recommendations made by the Finance Commissions (FCs) to help the states meet fiscal deficiency in providing a minimum standard of services to their people. This calls for assessing the states’ ‘needs’ on rationale and equitable basis. FCs use appropriate criteria to assess the true needs of the states. Population proxies very well for the needs of the people in a quantitative sense. Another criterion, the Income Distance, which captures very well the relative poverty of people in the states, is used to assess qualitative needs. These two parameters allocate more resources to the populous and poorer states, which need additional funds for providing education, health and other services to the people, which own resources of these poorer states may otherwise not allow.
The 14th FC had no specific mandate for using the 2011 Census. Yet, the 14th FC rightly used the 2011 Census population data to capture the demographic changes since 1971 to make a realistic assessment of the needs of the states. It allocated 10 per cent weight to 2011 population. The 14th FC had allocated a 42 per cent share in the central taxes to the states more than ever before.
There is a specific inclusion of another reference, i.e. ‘efforts and progress made in moving towards replacement rate of population growth’ in the Terms of References of the 15th FC. This ToR recognises the efforts of all the states which have done well in population control. This specific ToR would allow the 15th FC to propose a specific incentive scheme to reward the states which have achieved the replacement level of population growth, and also, if the 15th FC wishes to do so, to assign appropriate weight to the progress made in population control while allocating resources.
The ToRs of the 15th FC rightly balance both the ‘needs’ represented by the latest population and “progress towards population control” very well. There is no inherent bias or mandate in the ToRs of the 15th FC that may be construed as discriminatory against the states which made good progress in population control.
Arun Jaitley, Union Finance Minister (Facebook post)
Population — A bone of contention
Nov 22: Cabinet approves setting up of the 15th FC for 2020-25
Nov 27: President appoints NK Singh as its chairman
One of the ToRs directs the 15th FC to use 2011 population data
- Apr 10: FMs of Kerala, Karnataka, AP and Puducherry meet
- They protest against the ToR for using the 2011 population data
- FM Jaitley clarifies that the ToR recognises efforts of states in population control
- Apr 22: Kerala FM Thomas says that the disgruntled states to meet again on May 7
- Punjab FM Manpreet Singh Badal and Delhi FM Manish Sisodia to participate, he says
- Odisha, West Bengal and Mizoram to join them at Vijayawada, he adds
Mainly southern states fear that using 2011 population data (in place of 1971 census) for devolution of central taxes would penalise them for checking population growth and incentivise populous states like UP, MP, Bihar
The Finance Commission
- Set up under Article 280 of the Indian Constitution
- Constituted every five years to review financial situation of Union and states
- Recommends devolution of tax revenues between the Centre and states
- The divisible pool includes central taxes excluding surcharges & cess
- It also suggests measures for stable/sustainable fiscal environment
Composition and Tenure of 15th FC
- Chairman, NK Singh: Former MP and former expenditure & revenue secretary
- Member, Shaktikanta Das: Former economic affairs and revenue secretary
- Member, Anoop Singh: Adjunct Professor, Georgetown University
- Member (Part Time), Dr Ashok Lahiri:
- Chairman (Non-executive), Bandhan Bank
- Member (Part Time), Dr Ramesh Chand:
- Member, NITI Aayog
- Secretary, Arvind Mehta
- Tenure October 30, 2019
The 14th FC (2015-20)
- Chaired by YV Reddy
- Report laid in the Parliament on Feb 24, 2015
- All recommendations implemented from 2015-16
- Distribution of net tax proceeds of the Union between Centre and states
- 14th FC increased states’ share in the net proceeds to 42% from 32%
- Grant-in-aid to states for revenue deficit to be Rs 1,94,821 crore
- Grants: Panchayats Rs 2,00,292 crore; Municipalities Rs 87,144 crore
- Fiscal deficit for states at 3% of GSDP (flexibility of 0.25%)
The 14th FC on population issue
Though we are of the view that the use of dated population data is unfair, we are bound by our ToR and have assigned a 17.5% weight to the 1971 population. On the basis of the exercises conducted, we concluded that a weight to the 2011 population would
capture the demographic changes since 1971, both in terms of migration and age structure. We, therefore, assigned a 10 per cent weight to the 2011 population.
- Allocation of respective proceeds among states
Horizontal Devolution Formula in the 13th and the 14th Finance Commissions
Variable Weights accorded
13th FC 14th FC
Population (1971) 25 17.5
Population (2011 — for demographic change) 0 10
Fiscal capacity/Income distance 47.5 50
Area 10 15*
Forest cover 0 7.5
Fiscal discipline 17.5 0
Total 100 100
* 2% for smaller states
Sources: FC reports/PIB/Economic Survey/prsindia.org
Share of states in Rs 100 pool
States Under the 13th FC** Under the 14th FC
Bihar 10.917 9.665
Haryana 1.048 1.084
Himachal Pradesh 0.781 0.713
J&K 1.551 1.854
Punjab 1.389 1.577
Kerala 2.341 2.500
Uttar Pradesh 19.677 17.959
** Share of all shareable taxes excluding service tax
Sources: 13th & 14th FC reports)
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