Are special category States justified?

With Chandrababu Naidu and Nitish Kumar proving indispensable to the NDA government, the demand for special category status for their States has now been revived with renewed vigour. Both have been passionately demanding this status.

Andhra Pradesh was promised this status in the floor of Parliament by the then Prime Minister Manmohan Singh when Telangana was carved out of it. Two of its most prosperous districts, Hyderabad and Ranga Reddy, that earned a bulk of the revenues for the undivided state, went to Telangana.

Nitish Kumar has raised this demand time and again and has even prepared a special paper highlighting why Bihar needs this status to address its backwardness.

Why Special Category

Eleven economically backward hill States, including all the eight North-Eastern States and the Himalayan States of J&K, now an UT, Uttarakhand and Himachal Pradesh, comprised the group of “Special Category States”.

They suffered from many drawbacks arising from their remoteness, geographical isolation and lack of resources, capital and infrastructure. The Centre sought to address this asymmetry by awarding them the “special category status”, giving them liberal access to Central funds.

This was rather an unimaginative, adhoc solution that relied solely upon the use of funds, ignoring their inherent structural weaknesses and capacity constraints. Once the status was awarded, the specific assistance pattern follows in perpetuity. While some States used the Central resources to their advantage, others could not do so for various reasons, including protracted insurgency and political instability combined with misgovernance.

But the flow of Central funds, unlinked to any performance expectations or accountability from the States, rather produced an overwhelming dependence of these States upon the Centre instead of empowering them. It led to complacency as well.

Background issues

During the Planning era, Central Plan assistance was provided to the States under the Gadgil formula. Under this, 30 per cent of the total Plan assistance was earmarked for the special category States, given on the basis of 90 per cent grants and 10 per cent loans, essentially for schemes approved by the Centre. This is, of course, distinct from untied transfers under the Finance Commission’s devolution formula.

This kitty of 30 per cent remained constant since 1969 even though the number of such States went up from three in 1969 to 11 in 2001. The 90 per cent grants and 10 per cent loans formula for special-category States over time was restricted only to the Centrally-Sponsored Schemes (CSS), as opposed to a potentially larger coverage of State-driven schemes under the Gadgil formula. Initially around 70-80 per cent of the Plan transfers were covered under the Gadgil formula. But with the gradual unchecked proliferation of CSS and appropriation of most of the Plan resources by them through direct off-budget transfers to local entities under the Centre’s tutelage, the Gadgil transfers (30 per cent of Plan assistance to Special States) progressively went on shrinking.

‘Direct transfers’ were abolished in 2013-14 as a Constitutional anomaly as these bypassed State governments. In 2013, CSS were restructured — or rather repackaged — by bunching many smaller schemes under “Umbrella” schemes. The Planning Commission itself was disbanded in 2014.

However, the funds flow to Special States has continued through CSS, with accountability issues remaining unaddressed.

The Fourteenth Finance Commission report submitted in 2014 (which raised the States’ share in the divisible tax revenues of the Centre by 10 percentage points) did not make any specific recommendations for special States, giving an impression that the special category status has de facto been abolished, a view articulated by the then Finance Minister Arun Jaitley.

But to evaluate whether the status is still active, we have to consider two things — whether there has been a curtailment of resources of these States and whether they retain their relative advantages vis-à-vis other States. As I have shown elsewhere, the reality is that the benefits enjoyed by these States remain well protected.

Significant excise duty concessions and income tax holidays are also provided to companies for setting up new industrial units within these States, in addition to subsidies on transport, insurance, interest, etc. For these benefits, there have been demands from many States for this status, which also found favour in the era of coalition politics and wafer-thin majorities. However, in the absence of market, infrastructure and local resources, these incentives hardly helped to attract investments.

Need for a Relook

If the status is now awarded afresh to Andhra and Bihar the flaws of the existing mechanism must be corrected, which include the absence of any accountability and monitoring mechanism.

The status should be reviewed periodically and a target-based time-bound approach adopted for providing assistance. Suitable incentive for better performance and disincentives for sub-optimal performance should also be built into the system for it to work efficiently.

These States are unable to utilise a significant part of their existing budgetary allocations even now and unless they improve their institutional capacities, additional funds will only lead to additional waste.

The writer is a former Director General at the CAG of India