The 14th Finance Commission is about to be constituted. The Finance Commission makes recommendations on sharing of Central taxes with States, and determining grants-in-aid for States and local bodies. Apart from these constitutionally mandated tasks, it also has to address contemporary economic challenges. The Presidential order constituting the commission outlines a detailed set of tasks.

Macroeconomic challenges

The 13th Finance Commission was asked to suggest measures to maintain a stable and sustainable fiscal environment consistent with equitable growth. At that time, the Indian economy was recovering from the 2008-09 global economic crisis. From a high nine per cent, the growth rate had slipped to just above six per cent. Today, the macro-economic situation is worse.

The country is going through a phase of low growth and high inflation. Only 5.5-6 per cent growth is expected in 2012-13. Conventional measures of monetary or fiscal stimulation would only exacerbate inflation.

Supply-side measures are needed to stimulate investment and improve productivity. The 14th Commission might well be asked to examine strategies to stimulate growth that is stable and equitable.

Given the low growth and sluggish prospects of uplifting tax revenues relative to GDP, it will be quite a challenge for the Commission to resolve the vertical imbalance between the Central and State governments, and the horizontal imbalance among the State governments.

Core tasks

When it comes to sharing Central tax revenues with States, and determining State grants, revenue and expenditure assessment may yield a lower surplus with the Centre and a higher deficit with States. With a high subsidy bill and other committed expenditures, the Centre would have a dwindling surplus, while the States need more resources to uplift services.

To resolve this imbalance, the Commission should take a comprehensive view of all transfers, including those from the Planning Commission and the Central ministries that have progressively become larger and more ad hoc. The use of 1971 population data to determine States’ share of tax revenues is hopelessly outdated.

Pursuing Tax Reforms

The 13th Finance Commission was asked to examine the impact of the proposed Goods and Services Tax implementation from April 1, 2010. The GST has remained elusive so far. The proposed constitutional amendment and ongoing discussions in the Empowered Committee of State Finance Ministers indicate two rates for goods, and a different one for services. The standard rate for goods is likely to be high. These features are not desirable.

The 14th Commission may be asked to examine the GST issue afresh and give an interim report within a year. It should explore new ways of setting States’ concerns at rest. These could include a permanent mechanism for compensating States for revenue losses resulting from the abolition of Central sales tax, supplementary non-rebatable tax for demerit and polluting goods, bringing taxation of petroleum products within GST, and a low-core GST rate for goods and services.

Fiscal Consolidation

The Central and State governments have committed to limiting fiscal deficit relative to GDP and GSDP, respectively, at three per cent, and achieving balance on the revenue account. They have both slipped on these targets. The Central Government’s slippage is greater. The Commission will have to recast the fiscal consolidation path through tough fiscal discipline rules, particularly for the Central Government. Furthermore, it should also review rational ways of handling significant non-tax revenues from natural resources on the surface (such as water), underground (such as coal), and in space (such as spectrum).

D.K. Srivastava is Chief Policy Advisor, Ernst and Young

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