Risks to fiscal federalism

To minimise risks, the president may consider seeking response from states and the Centre on the 15th Finance Commission's suggestions

The government has proposed to the president to extend the 15th Finance Commission's term by a month, and mandate the panel to suggest ways for allocation of non-lapsable funds for defence and internal security.

Under the terms of reference (ToR) of the Commission, it is proposed to ensure an assured allocation of resources towards defence and internal security imperatives. “The amendment provides that the XV Finance Commission shall also examine whether a separate mechanism for funding of defence and internal security ought to be set up and if so how such a mechanism could be operationalised," an official statement said.

The proposed additional ToR raises a number of questions. First, how does it fit into the overall scheme of fiscal federalism, Budget and financial management, as per our Constitution? The taxes collected by the Union government to be shared with states are distributed between the Centre and states after deducting the collection charges attributable to states. The respective shares are allocated to the consolidated fund of India for the Union government and the consolidated fund of the respective states. Grants-in-aid, as recommended by the Finance Commission, are transferred out of the resources of the Union government which includes the Union government's share of taxes.

Second, the allocation for defence is entirely the responsibility of the Union government.  In fact, the 14th Finance Commission (FFC) had recognised the inadequate allocations in the past, as the following extracts will show:

“...Accordingly, its projections have provided for an increase in defence revenue expenditure (including salaries) of 30 per cent in 2016-17 which will incorporate the Pay Commission impact, with a stable growth rate of 20 per cent per annum in the remaining years (Para 6.35).”

“Much of the demand on resources from the Ministry of Defence has been in the nature of capital expenditure, which is beyond the scope of our (FFC) assessment. Recognising that revenue expenditure is critical for defence preparedness and maintenance, we (FFC) have kept the defence revenue expenditure-GDP ratio constant during our projection period, instead of allowing growth to decelerate as was the case in the past. In other words, the rate of defence revenue expenditure has been allowed to increase at the same rate as the GDP, which is substantially higher than the past growth of defence revenue expenditure (Para 6.36).” 

Yet, it was the Union government that has been empowered by the Constitution to make an actual allocation to defence. Is it appropriate for a body like Finance Commission to suggest specific allocation for an important sector with implications both for the spirit of Parliamentary control over expenditure allocations and the changing demands of security considerations?

Third, internal security to a substantial extent is the responsibility of state governments since law and order is their responsibility. In fact, when the services of the Central Reserve Police or the Border Security Force are requisitioned by state governments, they have to be paid for out of their Budgets. Further, when their services are utilised by state governments for the purpose of elections exclusively, state governments pay for them. When elections are held simultaneously, such expenses are shared between the Union and states. In brief, both Union and states have respective needs on account of defence and internal security, respectively.

It is hoped that the XV Finance Commission will consider these fundamental issues apart from operational problems and, in any case, it is not obliged to give its recommendations on each and every ToR.

On the process of consultation with states in finalising the ToR of the Finance Commission, the Sarkaria Commission observed: "Any consultation to be meaningful should be adequate."  This particular ToR has serious implications for the Union-state relations. Have states been consulted or will they be consulted on the additional ToR?

The Constituent Assembly in its deliberations concluded that the acceptance of the recommendations should not be left only to the Parliamentary approval since the recommendations affect both the Union and state governments. Hence, the Constitution provides for placing of the action taken on every recommendation together with an explanatory memorandum by the president of India before Parliament. The assumption is that the president will exercise his discretion and act not merely as head of the Union, but as head of the Republic of India consisting of the Union and state governments.

In view of recent developments, the practice of keeping the recommendations of the Finance Commission confidential until the decisions are taken and action taken placed before Parliament has implications for the fabric of Indian fiscal federalism.  To minimise risks, the president may consider placing the report of the XV Finance Commission in the public domain and also seek specific responses from state governments and the Union government before a final view is taken on the recommendations.

In this connection, it may be useful to quote extracts from the Republic Day speech of a chief minister in 2012:

“There is even larger destruction of the federal structure in fiscal areas. In the name of ‘public good’ or ‘people’s rights’, more and more funds are making their way to New Delhi. The Finance Commission allocated substantially lesser resources to states keeping the lion’s share of funds with the Centre. The Centre has become adept at passing populist schemes but there is no financial support given to states for their execution. Adequate central funds are not an obligation from New Delhi but the right of every state to pursue development.”

“These concerns I am sharing today are not only as a chief minister but also as a common citizen of India. Why is it that chief ministers cutting across party lines are expressing serious apprehensions on these repeated attacks on India’s federal structure? It is high time the Centre realises that giving to the states what rightfully belongs to them will not weaken the Centre. The states must co-ordinate with the Union government and not remain subservient to it. Co-operative and not coercive federalism must be the norm in our country."

The writer is former governor, Reserve Bank of India