The Thirteenth Finance Commission was constituted last week, under the chairmanship of Vijay Kelkar, a former finance secretary and advisor to the finance minister. During his tenure in the latter position, he chaired two task forces on direct and indirect taxes, respectively, and authored a report which laid out a roadmap for the implementation of a national goods and services tax and its integration with the state value-added tax (VAT). From the tax perspective, the Commission's main challenge will be to develop a revenue-sharing mechanism in the dramatically different context that a national goods and services tax will create. The task will become even more complicated when VAT offsets begin to apply to inter-state transactions, rather than the in-state transactions that they are confined to now. With his background, Dr Kelkar is eminently qualified to chair the Commission, which is expected to submit its report by October 2009, with its recommendations relating to the sharing of tax revenues between the Centre and the states coming into effect from April 1, 2010. | |
| That said, the most important challenge facing the Commission has more to do with the spending side of the resource equation than the tax revenue side. Over the last few years, there has been a significant improvement in the condition of state finances as a whole, though the pattern varies across states. A number of factors have contributed to this healthy situation. One, central revenues have been buoyant as a result of the acceleration in economic growth. Given the existing sharing formula, this puts more resources into the states' kitty. Two, the implementation of VAT by most major states in 2005 resulted in a substantial increase in revenue collections in many of them. Three, the Twelfth Finance Commission provided incentives for fiscal improvement through a combination of debt write-offs and lower interest rates in exchange for meeting deficit reduction targets. In doing this, it strongly reinforced incentives for fiscal discipline that had been initiated by its immediate predecessors. These factors combined have seen the combined fiscal deficit of the states (as a percentage of GDP) fall even more sharply than that of the central government over the past couple of years. |
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| That is the positive side of the fiscal story. In stark contrast is the ability of governments to spend these additional resources efficiently. Public services everywhere are falling desperately short of even minimal quality standards and capital spending projects are inevitably marred by huge cost and time overruns and inadequate capacity. There isn't much point in governments having more money to spend if they cannot spend it effectively. The new Finance Commission needs to make this issue its top priority. The use of incentives to rein in deficits appears to have worked reasonably well. It is now time incentives and conditionality were used to induce states to spend their money wisely. The Commission must come up with creative ways, within the confines of its statutory mandate, to reward states that spend effectively and penalise those that do not. Ideally, this would involve linking some component of the total funds being transferred to specific socio-economic outcomes; within the relatively short time-frame of five years, however, credible institutional reforms and greater accountability for deliverables might have to suffice. Anything will be an improvement on the status quo. |
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