Why the fifteenth finance commission report merits a proper discussion

It is vital that we have a proper discussion on the medium-term economic and fiscal situation based on the Fifteenth Finance Commission medium-term assessment

The Fifteenth Finance Commission (FFC) submits its final report to the president on November 9. The document will then be discussed by the Central government and presented to Parliament, together with an action taken report which specifies whether, or to what extent, the government accepts the recommendations of the report. 

A clear decision has to be conveyed on the share of centrally-collected taxes that will accrue to the Centre (the vertical devolution, the formula by which the share of individual states shall be determined (the horizontal devolution), because this information is necessary for the preparation of Central and state government budgets for 2021-22. Hence, the report needs to be tabled before Budget Day, 2021. 

This report assumes particular importance at the current juncture for three reasons 

First, the FFC submitted an interim report last year, citing the reorganisation of Jammu and Kashmir, global “synchronised slowdown” and the deceleration in the domestic growth rate as reasons. Thus, this report will analyse the impact of the coronavirus pandemic on an economy that was, by the Commission’s own admission, already slowing down. It will take cognisance of the fiscal implications of the growth slowdown, compounded by the impact of Covid, on the fiscal position of the Central and state governments, because it is required to present a five-year assessment of what will happen to growth, tax revenue collection and expenditure aggregates for both levels of government, in order to justify its recommendations on the vertical and horizontal devolution. 

Second, the finance ministry has not presented a medium-term fiscal road map, unlike most other large economies. There is no other entity in government that has the mandate to do so. The FFC recommendations on fiscal consolidation will, in effect, provide this, and it will be incumbent on the Government of India to then say whether it endorses such a view and, if not, what its alternative view is. 

Third, state finances are severely strained. The states bear a disproportionate share of the fiscal responsibility for dealing with the pandemic. The Centre seems to have taken the view that its finances are too constrained to provide significant direct fiscal support; it is not providing grant financing to the states either, instead asking them to borrow, even to make up for the shortfall in the goods and services tax (GST) compensation cess. Over time, the share of the states in the divisible pool has eroded to 33 per cent, far below the 42 per cent mandated by the previous finance commission, as the Centre has sought to corner tax revenues by imposing cesses, rather than increasing tax rates. Cesses are not shareable with the states. 

In addition, tax GDP ratios have been falling and GST has caused volatility in state finances. The Reserve Bank of India’s latest report on state finances shows that revenue receipts of the states in 2019-20 were  Rs 4 trillion lower than projected in the budget estimates. The pandemic is forcing the states to borrow heavily, with the blessing of the central government, resulting in the erosion of hard won fiscal prudence and declining quality of fiscal spending. And then there is the fracas over the GST compensation cess. 

To compound all this, the terms of reference of the FFC enjoin it to take note of many things that impact the autonomy of the states, including control on “populist measures” (though not for the Centre), adoption of direct benefit transfers and progress on flagship central government schemes. Why should states be forced to adopt these priorities in a democracy? The FFC response to this can be politically contentious, especially if presented as a fait accompli. 

But the Central government bureaucracy is not self-confident, or given to speedy analysis, unless pushed. For this reason, finance commission reports are typically tabled in Parliament only a day or two before the budget is presented. The government presents its decision, without discussion, as a fait accompli. 

There is a constitutionally validated asymmetry that gives the Centre a privileged position on this matter. The states have no voice on whether, and which, recommendations are accepted by the Centre, but the consequences have to be borne by them. 

It is vital that we finally have a proper discussion on the medium-term economic and fiscal situation based on the FFC’s medium-term assessment. Most important, given the situation with state finances and the tension in inter-governmental fiscal relations, the state governments should not be presented with a fait accompli. The report of the FFC should be tabled in the 2020 winter session of Parliament. 

Article 281 of the Constitution requires the government to table an action taken report. This can specify the vertical and horizontal devolutions and, possibly, elements of the fiscal consolidation road map. As was done the last time, actions on the other recommendations can be placed in due course. This would enable the state governments to prepare better budgets for FY 2021-22. It would allow discussion on the five-year assessments and the medium-term road map, which would add credibility to the fiscal formulation process. Doing this would be particularly important if there are politically contentious recommendations, including, but not limited to, an increase in vertical devolution to the Centre. 

Prime Minister Narendra Modi, when chief minister, was a fierce advocate of the Centre engaging with the states as partners. History would applaud his consistency of principle if he were to give this proposal serious consideration — in the public interest.

The writer is managing director, ODI, London; r.roy@odi.org Views are personal