Finance Commission confronts fiscal prudence challenges with minimal ToR

Experts say minimum ToR issued to avoid controversies and simplify state memoranda

Breaking away from precedent, the government has issued bare minimum terms of reference (ToR) to the proposed 16th Finance Commission, limiting it to what is broadly enshrined in the Constitution. Nonetheless, the commission cannot avoid addressing issues of fiscal prudence and sustainability even if this ToR is retained, say experts.

Some experts, who were part of previous commissions, also feel that the government may refrain from issuing additional ToR to avoid controversies and the awkward position of rejecting uncomfortable recommendations.

The Union Cabinet recently approved ToR for the 16th Finance Commission, according to which the body would make recommendations on the distribution between the Union and the states of the net proceeds of taxes, the principles governing grants-in-aid of the revenues of states, and the measures needed to augment the consolidated fund of a state to supplement the resources of the panchayats and municipalities in the state.

Additionally, the ToR also included a review by the proposed commission of the present arrangements for financing disaster management initiatives.

The recommendations on the financing of disaster management initiatives and local bodies have been part of successive finance commissions since the 6th and 11th commissions, respectively.

While there were expectations of a detailed list of references at the time of the constitution of the commission, Finance Secretary T V Somanathan recently clarified that there would be no further ToR beyond what was announced by the Cabinet.

“These are shorter than those of recent commissions. This gives the commission greater leeway to take into account the different inputs that they get from stakeholders that appear before the commission,” Somanathan had said.

C Rangarajan, chairman of the 12th Finance Commission, points out the press note issued after the Cabinet meeting  last month says the ToR for the 16th finance commission will be notified in due course of time. He says he is not sure whether the government will come out with additional ToR. Going by what came out in newspapers, it appeared that the government is strictly going by what is given in the Constitution. 

Rangarajan says that is not a bad idea, but hopes that the commission will go into fiscal and debt issues that could have been raised in the ToR.

“Questions of how much of the shareable revenues should go to the states and how they are horizontally distributed also relate to fiscal prudence and fiscal performance," he says.

While the commission has not been asked directly to comment on what should be done to maintain fiscal prudence, the commission will, however, have to take note of these issues while deciding on the terms that have been referred to it,  says Rangarajan, who served as Reserve Bank Governor in 1990s, says.
 

Previous Finance Commissions were also asked to look into various specific issues, besides fiscal prudence and sustainability.

For instance, the 12th Finance Commission was asked to recommend whether non-tax income of petroleum to the Union should be shared with states from where the mineral oils are produced, and the 13th Finance Commission was called upon to take into account the impact of the proposed implementation of the goods and services tax (GST), including its impact on the country’s foreign trade; the next body was requested to review the subsidies required for sustainable and equitable growth; the 15th Finance Commission was told to assess the impact of GST, including payment of compensation for possible loss of revenues for five years.

Rangarajan, who also headed the Prime Minister’s Economic Advisory Council during the United Progressive Alliance government, says it is best to avoid a long list of ToR.

“Giving a long list of ToR to the constitutional commission should be avoided. But what I am saying, issues such as the nature of public borrowing, the level of borrowing, though not indicated in the current ToR, would be required,” he says.

Govinda Rao, a member of the 14th Finance Commission, says, the government is restoring what the Constitution wants the Finance Commission to do.

He says the past commissions also recommended the fiscal target and creation of the fiscal council. It did not become very convenient for the government to say that it rejected these recommendations.

“Possibly, it is saying that it will set fiscal targets for itself rather than asking the Finance Commission to do so. The 14th and 15th Finance Commissions made recommendations for creating an independent fiscal council,” he says.

The government possibly wants to avoid any such antecedents, he says.

Rao also believes that a long list of ToR leads to a possibility of controversies.

He points out that the 15th Finance Commission was asked to factor into the 2011 population census while giving its recommendations, instead of the 1971 used by many of the previous commissions.

The reference was opposed by the southern states, alleging that it would go against them as they controlled the population much better than many other states.

Also, the 15th Finance Commission was asked whether revenue deficit grants be given at all, Rao recalls, adding that particular ToR also created controversy.

Rao believes that a short list of ToR also helps many states because in their memoranda they would focus on what the requirements are, rather than taking into account deficits, debt, etc.

Sumit Bose, secretary of the 13th Finance Commission, says the Finance Commission has enough leeway to work even if ToR is strictly restricted to what is laid in the Constitution.

The Finance Commission is set up under Article 280 to provide recommendations on the devolution of the central taxes to states and the principles which should govern the grants-in-aid by the Centre to states out of the Consolidated Fund of India.

The Article also empowers the President of India to refer any other matter to the commission in the interests of sound finance. It is under this provision that the Union government issues ToR to the commission which are beyond the minimum ToR.

Major terms of reference other than what is strictly given in the Constitution:

First Finance Commission (1952-57)

Grants-in-aid for Assam, Bihar, Odisha and West Bengal in lieu of export duty on jute and jute products

Second Finance Commission (1957-62)

The principles to govern the distribution of additional duty of excise on mill made textiles, sugar and tobacco to the states.

Third Finance Commission (1962-66)

The manner to distribute among the states Rs 12.5 crore which the Railways have agreed to pay to the general revenues every year; the principles governing the distribution of the additional excise duties levied cotton fabrics, rayon or artificial silk fabrics, silk fabrics, woolen fabrics, sugar and tobacco among the states.

Fourth Finance Commission (1966-69)

The principles to govern the distribution of the net proceeds of such additional items or commodities on which additional excise duties could be imposed in lieu of the sales taxes, the scope for raising revenue from the taxes and duties not levied at present; the problem of unauthorised overdrafts of certain states with the Reserve Bank.

Sixth Finance Commission (1974-79)

An assessment of the non-plan capital gap of the states; review the policy and arrangements regarding the financing of relief expenditure by the states affected by natural calamities and examine the feasibility of establishing a national fund.

7th & 8th Finance Commissions (1979-84):

Broadly in line with the sixth commission.

Ninth Finance Commission (1989-95)

An assessment of the debt position of the states as on March 31, 1989 and suggest corrective measures.

Tenth Finance Commission (1995-00)

Review the present scheme of Calamity Relief Fund; an assessment of the debt position of the states as on March 31, 1994, and suggest corrective measures.

Eleventh Finance Commission (2000-05)

The measures needed to augment the Consolidated Fund of the states to supplement the resources of the panchayats and municipalities on the basis of the recommendations made by the respective state finance commissions.

Twelfth Finance Commission (2005-10)

Review the state of the finances of the union and the states and suggest a plan of restructuring of the public finances restoring budgetary balance, achieving macroeconomic stability and debt reduction; review the Fiscal Reform Facility introduced by the Centre on the basis of the recommendations of the 11th Finance Commission; an assessment of the debt position of the states on March 31, 200 and suggest such corrective measures; review the present arrangements regarding financing of disaster management with reference to the National Calamity Contingency Fund and the Calamity Relief Fund, assess whether non-tax income of petroleum to the Union, arising out of contractual provisions, should be shared with the states from where the mineral oils are produced

Thirteenth Finance Commission (2010-15)

Review the state of the finances of the Union and the states and suggest measures for maintaining a stable and sustainable fiscal environment consistent with equitable growth; review the roadmap for fiscal adjustments and suggest a suitably revised roadmap, keeping in view the need to bring the liabilities of the Centre on account of oil, food and fertilizer bonds into the fiscal accounting; factor into the impact of the proposed implementation of GST.

Fourteenth Finance Commission (2015-20)

Review the state of the finances, deficit and debt levels of the Union and the States and suggest measures for maintaining a stable and sustainable fiscal environment consistent with equitable growth including suggestions to amend the Fiscal Responsibility and Budget Management Acts currently in force; to take into account the impact of the proposed GST on the finances of Centre and the states and the mechanism for compensation in case of any revenue loss; factor into the resources available to reorganised states on reorganisation of Andhra Pradesh

Fifteenth Finance Commission (2020-25)

Review the current status of the finance, deficit, debt levels, cash balances and fiscal discipline efforts of the Union and the states and recommend a fiscal consolidation roadmap for sound fiscal management; propose performance-based incentives for the states including efforts made by them in expansion and deepening of tax net under GST, in moving towards replacement rate of population growth and achievements in implementation of flagship schemes of the Union; will use the population data of 2011 while making its recommendations.