It goes to the credit of those who drafted the terms of reference (ToR) of the Commission that they simply reproduced the tasks specified in Article 280 and avoided nudges or directives to the Commission, unlike in the past. It also goes to the credit of the Commission that it has not rocked the boat, and that there is a strong measure of stability and continuity in its recommendations. The Commission has continued with the devolution of 41 per cent of Union taxes but discontinued the practice of recommending revenue-deficit grants.
For the horizontal distribution of devolved taxes, the most significant change in the formula is the introduction of the contribution of states’ share in the national gross domestic product (GDP). It assigned a 10 per cent weighting to this factor by reducing the weighting of per capita income distance and demographic performance by 2.5 percentage points, and that of area by 5 percentage points. It removed the 2.5 per cent weighting assigned by the 15th Commission to the tax effort factor and added this to assign a 17.5 per cent weighting to population share.
The weight for demographic performance was reduced by 2.5 percentage points and instead of taking the inverse of fertility change, it took the inverse of population growth between 1971 and 2011 Censuses. Similarly, the forest cover variable was weighted by its density. The Commission discontinued the practice of recommending state-specific and sector-specific grants.
The vertical transfers are broadly based on the Commission’s judgement about the relative capacities and needs of the Union and the states in carrying out the functions assigned to them in the Constitution. However, in evaluating horizontal transfers, it is important to see to what extent the transfers are aligned with the rationale for transfers in a federal system.
The transfers may be for general purpose (unconditional) or for specific purposes. The rationale for the former is to “enable” every state to provide a comparable level of public services at comparable revenue effort, which implies, offsetting the states’ revenue and cost disabilities and incentivising revenue effort.
The general-purpose transfer is unconditional and allows the states to provide services according to the varying preferences of the people residing in them. However, specific grants are given to “ensure” minimum standards of services considered “meritorious” or those that entail significant externalities, so that every citizen can have access to a prescribed minimum of such services.
The tax devolution is a general-purpose transfer and is distributed to the states by the Commission broadly based on factors representing revenue and cost disabilities. The 16th Commission gives the rationale that using contribution to GDP serves the purpose of efficiency, as this is presumed to incentivise states to implement policies to maximise the growth of their GSDP.
While, as a general proposition, this may be attractive, the introduction of this factor conflicts with the revenue disability factor, and its effectiveness will depend upon its electoral impact. More importantly, in a federalism marked by “competitive inequality”, the states are not on a level playing field, and the capacity to respond to the incentive differs widely among them.
Those with better social and physical infrastructure and more responsive institutions perform better than others. The Commission’s recommendations cannot be expected to fully offset revenue and cost disabilities, and infrastructure deficits in low per capita income states persist, as the Fiscal Responsibility and Budget Management (FRBM) Acts restrict them to borrowing only up to 3 per cent of their GSDP.
Doing away with revenue-deficit grants also raises some issues. The devolution based on revenue and cost disabilities does not address the specific problems of individual states, and grants can help in better targeting. At the same time, the inability to make normative assessments objectively raises both equity and incentive problems, which I had described in my earlier writings as “tyranny of the base year” and “fiscal dentistry”. Projections made on base-year numbers fail to address the service-level deficits in disadvantaged states, and filling in budgetary cavities by the Commission increases the size of cavities over time. Dispensing with revenue-deficit grants is one way to avoid this, but it rebalances the fiscal architecture.
The Commission is obsessed with the view that the 14th Finance Commission was unduly generous to the states in increasing tax devolution from 32 per cent to 42 per cent and repeats this assertion in several places in the report. It sounds most irresponsible of the 14th Commission to have done so! Ironically, nowhere does the Commission recognise the fact that the 14th Commission, unlike past Commissions, had to consider both plan and non-plan requirements of the states and had to subsume the Gadgil formula grants.
Besides, the Commission desisted from giving separate sector- and state-specific grants. It may be recalled that the 13th Commission recommended separate grants for environment, roads and bridges, governance, elementary education and many state-specific grants. If we consider only the tax devolution, revenue-deficit grants and the subsumed Gadgil formula grants, the difference is not that dramatic. The tax devolution and revenue-deficit grant share in the gross tax revenue of the Centre works out to be 38.5 per cent, which is marginally higher than the tax devolution, revenue-deficit grants and Gadgil formula grants given by the 13th Finance Commission. The marginal increase was because the Commission preferred the Union to confine Centrally Sponsored Schemes (CSS) only to “critical” services and not make forays into several sectors in the State List.
This brings us to the view of the 16th Commission on the CSS. The Commission asserts, “The CSS have played a crucial role in the nation’s development” (p.142). Have they really? As mentioned earlier, the specific-purpose transfers are required to ensure minimum standards of “critical” services. Do the “critical” areas extend to 29 umbrella schemes?
Many of the schemes are simple aggregations of more than 200 schemes that existed from the mid-1980s. In fact, the P V Narasimha Rao Committee was the first to report on the proliferation of schemes in 1988. These are mostly financed from cesses, thus eroding the divisible pool. Besides, is there any scheme in which the objective of achieving the minimum standard is specified? Even in the Sarva Shiksha Abhiyan, there are 42 different interventions. The Action Agenda paper of the NITI Aayog released in 2017 stated that there are approximately 2,000 budget heads in the health sector alone. The initial allocation and the ultimate spending pattern of all the schemes are vastly different. Even in Mgnrega (now subsumed under GRAMG), Tamil Nadu, a state with a lower poverty ratio receives a much higher allocation than Bihar. If the grants to these “critical” services are not designed and implemented to achieve minimum standards, what economic objective are they expected to serve?
The author was director, National Institute of Public Finance and Policy, and member, Fourteenth Finance Commission. Views are personal
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