Fiscal Breakthrough

The federal fiscal system has been creaking for quite some years now and had come under renewed strain after the stabilisation programme and the reform of the taxation system initiated by the Centre in 1991. In the initial years, the states bore the brunt of fiscal adjustment as plan transfers were significantly reduced.

The new system of devolution is a simpler and more efficient system of tax sharing than the one in operation. In the current system, the Centre devolves 47.5 per cent of the net collection of excise duties and 77.5 per cent of the net proceeds from income tax. On an average the devolution on this basis has been about 25 to 26 per cent of the Centres total tax receipts. In addition to this, the states have a tax rental arrangement with the Centre in the case of additional excise duties in lieu of sales tax. This has been in the range of 3 per cent of the total tax receipts of the Centre. Thus, the 29 per cent which will be devolved to the states is not a hike in their total entitlements.

The real gain from the new system is that it allows the states to partake of the enhanced buoyancy of all the taxes which will result from tax reforms. This is especially so since the pool will include tax on services under Article 269, which has a lot of revenue generating potential. On its part, the Centre will get total freedom to pursue integrated tax reforms without being accused of depriving the states of their share. It also removes the uncertainty about their share in taxes which the states are now subject to every five years. To that extent the new system is also more stable.

Pooling of all taxes should be seen as only the first step in reforming the federal fiscal system. The Constitution has recognised the vertical imbalance between the functions and finances assigned to the states and provided for vertical transfers. However, devolution does not fully compensate for the fiscal disadvantage faced by the states, and so grants-in-aid are given to meet the states deficit. Over the years, this system of deficit-based grants has generated an inefficient and irresponsible fiscal attitude in the states, which incur all types of expenditure, run a high deficit and expect the finance commission to meet the deficit through grants. This is obviously unsustainable. Therefore, the system of deficit-based grants should be done away with. The eleventh finance commission, which will be constituted shortly, should focus on this issue as it would be a major step towards bringing about the much needed efficiency in the management of state finances