Policy pillars: Finance Commissions, tax devolution and fiscal balance

Finance Commissions have a critical role in fostering the balance between fiscal capacities and needs of the Union and states, and among the states inter se

An article by a member of the 16th Finance Commission highlighting the generous tax devolution recommended by the 14th Commission deserves to be examined in the context of the theory of intergovernmental finance, assignment system given in the Constitution and the history of previous finance commissions.  

 

Finance Commissions have a critical role in fostering the balance between the fiscal capacities and needs of the Union and states, and among the states inter se. In doing so, they are required to consider the principles of intergovernmental transfers and the role and responsibilities assigned to them in the Constitution.  

 

As stated by the Sixth Finance Commission (p.7), the task of the Commission should be seen as “…the distribution of available resources as between the subjects coming constitutionally within the competence of Centre and those coming within the purview of states.”   Thus, the task of the Commission is to allocate the fiscal resources for the constitutionally mandated tasks and not for overlapping functions.  

 

A member of the 16th Finance Commission repeats his charge that the 14th Commission “… cannot by itself account for the 10 per cent (sic) increase in the states’ share of the divisible pool”. He argues that the Commission had: (i) no mandate to take into account the plan expenditure requirements when the previous commissions did not, and there was no mandate to retrofit the budget reform of doing away with the plan/non-plan classification implemented in 2017-18 in 2014-15 itself; (ii) the inclusion of plan requirements do not justify a 10 percentage point increase; (iii) the normative approach adopted by the previous commission was ineffective because there was no relationship between revenue deficit grants and actual revenue deficit; and (iv) the subsidies and transfers of the Union government are different from the untargeted consumption subsidies given by the states, and centrally sponsored schemes (CSS) have played a very important nation-building role.  Each of these points require critical examination.

 

It may be noted that Article 280 defines the Commission’s scope as meeting the entire revenue expenditure requirements of states. In fact, the Terms of Reference (TOR) of the first three Commissions did not limit the scope to non-plan requirements. By the time the third Commission submitted its report, the Planning Commission, with no roots in the Constitution but created by a Cabinet Resolution had become prominent and the Union government rejected the majority recommendation and accepted the note of dissent by the Member-Secretary that the Commission should cover only the non-plan requirements, leaving plan requirements to the Planning Commission. The subsequent Commissions until the 14th were explicitly mandated in the TOR to limit their scope to meeting non-plan requirements.

 

No such limitation was placed on the 14th Finance Commission in its TOR, and, had it confined itself to non-plan requirements, it would have violated its Constitutional mandate. It is not the case of retrofitting the reform but fulfilling the Constitutional obligation.  

How much additional requirements were entailed when the plan grants are subsumed in the Finance Commission’s scope? The estimate provided in the critic is incorrect. The states’ share of Union taxes in 2014-15 was ₹3.37 trillion and since this was 32 per cent, the divisible pool works out to ₹10.55 trillion.  The plan grants include normal central assistance, special plan assistance, additional central assistance, and backward region grant fund.  Together, these amounted to ₹1.02 trillion in 2014-15 and the normal central assistance (Gadgil formula grants) alone was ₹54,072 crore (Indian Public Finance Statistics, 2017-18;

Table 3; p.25).

 

As a percentage of the divisible pool, this works out to 9.5 per cent in the case of total plan grants and 5.1 per cent in the case of normal plan assistance alone. In fact, for 2013-14, the last year for which information was available to the 14th Commission while formulating its recommendations, the normal assistance itself was 7.5 per cent of the divisible pool. In addition, the 14th Commission excluded grants for ecology and environment (as forest cover was included in the devolution formula), grants for maintenance of roads and bridges and several state-specific and sector-specific grants recommended by the 13th Commission.  

It is also instructive to note that the Commission suggested a ceiling of total transfers at 49 per cent of the gross tax revenues, which implied that the CSS should have been limited to ‘meritorious’ services with large spillovers. In para 6.17, the Commission states, “Our examination ….shows that between 2002-05 and 2005-11, revenue expenditure by the Union government on State List subjects increased from an average of 14 per cent to 20 per cent and on Concurrent List subjects from an average of 13 per cent to 17 per cent. This implies that the Union government has been using the resources to encroach on the State and Concurrent subjects. 

 

The expansion of CSS was done by reducing the divisible pool of taxes by levying cesses and surcharges and proliferation of cesses and surcharges to finance them.  

The argument that the actual revenue deficits turned out to be different from normatively assessed ones, betrays the ignorance on the analytics of fiscal federalism.  

According to the fiscal federalism theory, welfare gains accrue from providing public services in accordance with varying preferences in different jurisdictions. The objective of unconditional transfers is to enable the jurisdictions to provide comparable levels of public services at comparable tax effort.

This implies that it is for the elected governments in the states to decide the composition of public spending subject to the ceiling on borrowing set by the Union government under Article 293 (3). The purpose of the normative exercise is to ensure that the burden of one state’s profligacy is not borne by others. Some states may want to spend more on social services which has a larger revenue expenditure component and some others may focus on physical infrastructure by spending less on the social sector.  

 

The above discussion is not meant to state that specific purpose transfers to ensure minimum standards on “meritorious” services do not have a role to play. The question is: Are all the 28 umbrella schemes meritorious? Is there any scheme which specifies the targets and is designed to achieve them? A review of these schemes by this author in 2017 found that even in a scheme like the Sarva Shiksha Abhiyan, there were 42 interventions.

 

The critic has highlighted achievements in the Jal Jivan Mission. Vivek Chatterjee in a recent article in this paper (July 17) has shown that while the tap connection coverage has expanded, water supply to the taps has not been planned. Ironically, Tamil Nadu utilises more funds under MGNREGA than Bihar with the largest concentration of the poor. It is necessary to ask questions like what the opportunity cost of these schemes are, and whether there are more effective interventions to achieve targets.

 

If indeed they have done a job of nation-building, why has the 16th Commission itself recommended the establishment of a high-power committee to evaluate all CSS and urged the closure of those with inefficient resource-use?  

 

The writer is a councillor at Takshashila Institution and former director, National Institute of Public Finance and Policy. Views are personal.