Reshaping India's fiscal architecture

Indian Fiscal Federalism  
 

Y.V. Reddy and G.R. Reddy 
 

Oxford University Press; Pages 273, Rs 695

That the terms of reference of the 15th Finance Commission are contentious is beyond contestation. Whether it is the controversy over shifting the population base to 2011 from 1971 for determining states’ share in tax devolution, or the mandate given to the 15th Finance Commission to review the recommendations of its predecessor commission or, for that matter, recommendations that could entail creating incentives to states for implementing the centre’s flagship schemes.

These issues have been vociferously debated over the past months. Now, a new book titled Indian Fiscal Federalism explores these and many other issues in great detail. The book written by Y V Reddy, former governor of the Reserve Bank of India (RBI) and chairman of the 14th Finance Commission, and G R Reddy, advisor to the Telangana government, begins by carefully tracing the evolution of India’s fiscal architecture. Each chapter dwells on critical issues such as the approaches of various finance commissions through the ages, the changing nature of centre-state fiscal relations, public debt and so on. The authors have also examined the impact of recent changes on India’s fiscal architecture, such as the shift to the goods and services tax regime and the creation of the Niti Aayog. 

On the contentious issue of which population estimates are to be used for determining the distribution of tax revenues across states, the authors appear to be in favour of shifting the population base to 2011 from 1971. They argue that contrary to public perception it is not only the southern states that have witnessed a decline in their share in population between 1971 and 2011. Others such as Odisha, West Bengal, Punjab, Assam, Himachal Pradesh and Goa have also observed declines. “Fundamentally, the needs of the future cannot be assessed on the basis of the population of the past. The use of the 2011 census is less unfair than of the 1971 census,” note the authors. 

The terms of reference also suggest that the 15th Finance Commission take into consideration the fiscal situation of the Centre after the recommendations of the 14th Finance Commission, coupled with the continuing imperative of the national development programme, including New India-2022. 

Now, this is a rather unusual request.  As the authors note, “Should the finance commission become another instrument for such policies, undermining its role as an arbiter of competing demands from the Union and the states and as one that assures the predictability of transfers?” 

As these transfers typically fall outside the purview of the Finance Commission, the authors rightly note that “The 15th Finance Commission cannot avoid being perceived to be an instrument of political or economic agenda if it takes the goals for new India 2022 in its considerations too seriously.”

Another critical but often neglected issue in India’s fiscal debates is that of the phenomenal rise in the share of cesses and surcharged levied in the recent past. As revenue from these sources does not form part of the divisible tax pool and are not shared with states, many have argued that this subverts the spirit of cooperative federalism.  The authors estimate that the revenue from cesses and surcharges have risen from 2.3 per cent of the centre’s gross tax revenue in 1980-81 to 14.3 per cent or Rs 3.24 trillion in 2018-19 BE.

“These (cesses and surcharges) neutralise the increase in tax devolution recommended by successive finance commissions” note the authors, adding that “the hope that the share of cesses and surcharges will reduce with the roll-out of GST has been belied for now.” 

Another issue that has received less attention in public discourse is the impact of the dismantling of the Planning Commission on India’s fiscal architecture. Now, under the erstwhile regime, state governments often raised objections over the functioning of the Planning Commission. However, its successor, the Niti Aayog, had two specific opportunities to address these concerns, note the authors. 

The first opportunity arose with the restructuring of centrally sponsored schemes in the aftermath of the recommendations of the 14th Finance Commission. This was an opportune moment to evaluate the whole architecture of these schemes. 

However, while the Niti Aayog was involved in this process, the authors contend that the manner in which these schemes were structured shows that “the effort was only to shift greater responsibility on to states in terms of financing.” There was no qualitative change in either the design or implementation of the central schemes that was promised when the Planning Commission was wound up.

Another opportunity arose a few years ago when the Centre removed the distinction between plan and non-plan expenditure. The authors contend that this opened up space to undertake a comprehensive sector wise review of capital and revenue expenditures. However, this was not done.