 "finance commission")
The Finance Ministry this week gave Ritvik R Pandey, a Karnataka cadre IAS officer, the charge of the advance cell, the first office set up for each Finance Commission every five years.
It is understood that the terms of reference (ToR) for the 16th Finance Commission is being firmed up at the Prime Minister’s Office and are expected soon. Once the terms are finalised, the name of the chairman and the members of the Commission would be announced.
Pandey, an additional secretary level officer, will likely take up charge as member secretary of the new Finance Commission. All heads of the advance cell have gone on to be member secretary, who is responsible for the drafting of the commission’s final report and working as its chief of administration.
The Finance Commission is the most important organisation between the central government and the states on economic issues. It is set up every five years under Article 280 of the Constitution to decide how tax resources should be divided between the centre and the states and among states. A decision on appointing the commission’s chairman travels all the way to the Prime Minister. The 15th Finance Commission, headed by N K Singh, was appointed in November 2017.
The ToR of the 15th commission ran into some controversy because states objected to a clause on "populist measures" that said what they should or should not be spending on. “Control or lack of it in incurring expenditure on populist measures” was to be examined by the commission as part of the “measurable performance-based incentives for States”.
Before the new ToR is issued, 'Business Standard' spoke to economists, members of previous commissions and others to sense what should be the key priorities for the 16th Finance Commission.
As the Finance Commission typically laces its recommendations with allocation and guidance on expenditure pattern, the choices made by the economists also straddled both aspects.
Subsidies
All experts agreed that the topic of subsidy has to be thrashed through by the commission. “The new Finance Commission should think about carrots and sticks for states in the context of discouraging the use of freebies,” said Krishnamurthy Subramanian, former chief economic advisor to the central government. Just as the central government’s subsidy bill for FY24 is Rs 4.03 trillion as per budget estimates, an audit report by the Comptroller and Auditor General (CAG) noted that states on aggregate spent about 8 per cent of their revenue receipts on subsidy in FY20, the period before Covid-19.
All previous commissions have addressed the subsidy issue, often citing “populist measures”. States have pushed back. A study by PRS India, a think tank, shows close to 55 per cent of total subsidy offered by states was for free or cheap power. In Haryana, Madhya Pradesh, and Punjab, power subsidies constituted more than 75 percent of total subsidy payouts. The Reserve Bank of India’s latest report on state finances, however, shows that among the non-developmental expenditure of states, pension and administrative services are on top. In FY23, “budget allocations towards medical and public health and natural calamities have been lowered” to make room for such expenses.
Most economists were unwilling to speak on record about tackling the subsidy issue, but they all agreed that it will be the biggest challenge for the 16th Finance Commission.
GST
The 15th Finance Commission had little time to study the Goods and Services Tax (GST). While the ToR noted that “While making its recommendations, the Commission shall have regard…The impact of the GST”, it was more in the context of the payment of compensation for states' possible loss of revenue for five years.
The Finance Commission examines for division direct taxes like income and corporation tax and indirect tax, chiefly GST. Basic customs duty is not part of the divisible pool. When the 15th Finance Commission came into being in 2017, GST was just a few months old (it was enacted on July 1, 2017). To make states agree to the rollout of GST, the Centre promised them a 14 per cent annual revenue up side.
The revenue award ends in FY24,. States have to live with a GST growth that though healthy could be less. In FY24 till September, it has averaged 11 percent year on year, as per government data.
“In the Finance Commission mandate, vertical devolution and horizontal devolution, the dynamic nature of GST has not been understood so far,” said a senior government official.
It is also because key decisions on the indirect tax's devolution remain with the GST Council. It will be necessary for the 16th Finance Commission to consider the issue and get a sense of how states' finances will function and apportion revenue.
Finance Commissions balance the developmental needs of states and their ability to raise taxes through the mechanism of revenue deficit grants. The official said, unless the GST road map is internalised by the Commission during its award years –FY25 to FY29 – the aspect of revenue deficit grants will be akin to a huge guessing game.
Fiscal roadmap and pensions:
Govinda Rao, a former director of National Institute of Public Finance and Policy and a member of the 14th Finance Commission, said the top priority for the new commission is to ensure fiscal stability at the centre and states. “This requires reworking of the roadmap for the entire fiscal architecture in terms of deficit and debt,” he said. This was particularly necessary as the household sector’s financial savings has declined to 5.1 percent of the GDP.
Rao and Subramanian agreed that moves to return to the old pension scheme, as many states have demanded, have to be clipped. “Unmitigated disaster” is how Rao described such proposals and said the Commission should ask the states to make provision for this upfront to be eligible to receive any grant.
Capex, municipal budgets
One of the most heartening aspects of India’s recent public finance story is the focus on capital expenditure. Between FY21 and FY24, the central government’s capital expenditure, including grants in aid to states for creation of capital assets, has risen by almost three times: From Rs 6.4 trillion to Rs 13.7 trillion. In the budget for FY24, Finance Minister Nirmala Sitharaman offered a Rs 1.3 trillion support for states under the same head.
Bornali Bhandari, professor at National Council of Applied Economic Research, said: “Capex spending has been the standout reform in public finance and the Finance Commission has to find out ways to accelerate the trend. A lot of India’s growth momentum will depend on how well this trend is ring fenced”.
She said that while the Finance Commissions have the power to allocate funds to the third level of the governance – municipalities and panchayats – but they have been unwilling to take on states on the issue.
“Most of the labour reforms we talk about like low cost housing, shelter or even health support have to happen in cities,” said Bhandari. But there was hardly any city government willing to engage on these topics. Along with allocating funds, and pushing more municipalities to raise money from their own sources, this was a major issue according to her.
Climate finance
Many economists were not sure if climate finance should be included deeply in the ToR of the 16th FC. An economist with a multilateral development bank said, “it is better that the central government sets the pace and the states decide depending on their priorities”. He said the 16th Finance Commission cannot set a national yardstick to calibrate how the money they award should be linked to the climate goals.
Both RBI and Sebi have advised companies to seek out measures to tailor their policies with climate goals. India also has an aggressive climate agenda, but as a public finance expert put it: “The Finance Commission is set up only for two years and has no in-house expertise to dwell on this issue. It will be better for it not to get bogged down on climate -linked issues."
Bhandari disagreed, saying it is a necessary agenda. “It should consider aspects of climate finance as those are integral to the building up of infrastructure by the states,” she said.
Subramanian said: “Policies that enhance the climate for manufacturing through measures like land and labour reforms, reforms in the power sector or in logistics are areas that the Commission should look into”.
