States with more economic activity should get more from Centre: Rangarajan

Former governor of Reserve Bank of India says: 'I have reservation on the horizontal distribution'

The generation of economic activity of a particular State and the generation of taxes has to be taken into account and should be provided for when it comes to the distribution of money to the states, said C Rangarajan, former chairman of Economic Advisory Council to the Prime Minister and former governor of Reserve Bank of India.

Speaking about the horizontal devolution, the allocation between the states of the respective shares of net proceeds of tax, he said, "Whether the population should get the higher weight or not, I really have the view that the generation of economic activity of a particular state and the generation of taxes has to be taken into account and that should be provided for."

For example, in the days when income tax alone was distributed amongst the states, collection was one of the important criteria. It is because the economic activity of that particular state or unit has contributed to the income and it should get it, he said. He was delivering his presidential address after the Raja J Chelliah Memorial Lecture was delivered by former chairman of 14th Finance Commission YV Reddy at Madras School of Economics.

"Maybe the horizontal division is not the way to do it. If supposing a state doesn't confirm a roadmap that you have given, then where is the way out? Then it becomes a purely political question, whether the centre will accommodate or not. We need to send out some signal that fiscal prudence is important. States need to raise money on their own and therefore it is critically important," he added.

He added that while the equity and need criteria followed in horizontal devolution might be correct when the devolution was 25 per cent, but it might not be the right criteria when the horizontal devolution is 42 per cent.

"States do want a higher devolution than grants. I put it at this point as a theoretical proposition, mainly whether the criteria that holds good when the tax devolution is of a certain order, is appropriate when the tax devolution makes a quantum jump," he said.

He added that centre should focus on a few centrally sponsored scheme rather than adding new schemes. States which are spending less percapita on certain types of expenditures will be allowed to have expenditures increased at a faster rate than the others. "This is one of the ways of doing it, but this is a highly implicit way of doing it," he said.

The 12 Finance Commission, which was headed by him, took out the equalisation principle and applied in two sectors, which has shown difference in the sectors later, he added. He also said that the 14th Finance Commission has done a commendable job, taking bold view on the division of divisible pool while the earlier Finance Commissions made only marginal changes in the division.