The much-awaited report of the Thirteenth Finance Commission tabled in Parliament makes some interesting departures from the past, though the overall approach and methodology are not very different. The Terms of Reference required the Commission to foray into a number of areas and therefore, the Commission besides its conventional tasks, has also recommended grants for elementary education, environment, improving outcomes, maintenance of roads and bridges and for the implementation of the goods and services tax (GST).
On the road map for fiscal consolidation, the Commission has set consolidated debt target of 68 per cent for the Centre and states. The target set for the Centre is 45 per cent and for the states, less than 25 per cent. This would require the Centre to work out the restructuring plan for each of the years. The present economic environment does not allow either the Centre or states to front load the adjustment, which implies that both the Centre and states will be required to phase out their deficits to reach 3 per cent of GDP and 2.5 per cent GDP (3 per cent of GSDP) by 2014-15.
The innovation of the Commission is in its devolution formula. Unlike the conventional way of taking distance from the highest per capita GSDP, the Commission takes the fiscal capacity distance and gives 47.5 per cent weight, which is better, but only marginally. The Commission computes the average tax GSDP ratios separately for General Category States and Special Category States for the period 2004-07 and estimates per capita tax for each state using the group average. While this is an improvement, this could work against the poorer states when the relationship between taxable capacity and per capita SDP is non-linear.
Furthermore, the method offsets fiscal disabilities of the states only partially and the perverse incentives from the gap filling approach continue.
Another concern is regarding the recommendations on the GST and in some ways, this goes against the federal principle. While the model GST suggested by the Commission has all the desirable characteristics, in the given political environment, 'the grand bargain' may not conform to the suggested model.
There are serious questions on the methodology adopted by the task force in estimating the revenue neutral rates and to use five different methods and take the average of them makes a mockery of any research methodology. If indeed, the rates suggested by the macro model or the task force are finally adopted, the revenue shortfall could be large.
Hopefully, the 'grand bargain' will take a realistic view of revenue neutral rates. Furthermore, the Finance Commission could have left the issue of penalty to the 'Council of Finance Ministers', which the Commission has recommended.
The states may not be too happy because although the overall transfers are larger, much of them are purpose specific. However, the compulsions of fiscal adjustment at the Centre would not permit much larger flow of funds.
