The recommendations of the 14th Finance Commission (FC) have come at the right time. The Modi government abolished the Planning Commission, which was designing developmental schemes that resulted in an increase in discretionary plan transfers; the FC takes the process a step further.
The statutory recommendations of the FC, which enhances untied fiscal resources to States substantially, have been accepted by the Union government, clearly giving historic fiscal autonomy to the States.
The substantive point being made is that the majority of resources to States should flow in the form of untied transfers (tax devolution) rather than grants, and plan transfers should be non-discretionary in nature. For example, while the relative share of the tax devolution constitutes around 46.8 per cent of total transfers from 2009-10 to 2014-15, the plan grants including CSS have majority stake — around 54 per cent of the total transfers. The CSS with conditions and matching grants impinges on their fiscal autonomy and they have very little say in design and implementation.
However, the 14th FC has recognised that aggregate transfers (tax devolution, non-plan grants, plan grants including CSS) has been more than 60 per cent of total divisible pool in recent years, and therefore there is little scope to increase the share. What required to be addressed was the composition of transfers. In a departure from the previous FCs, the 14th FC does not distinguish between general and special category States; and rather it takes note of fiscal disability and expenditure responsibilities of the special category States to fill the resource gaps through tax devolution.
Major recommendations The major recommendations include increase in the share of tax devolution to 42 per cent of total divisible pool from 32 per cent during the 13th FC. Cess and surcharges, which constitute 13.14 per cent of the Centre’s gross tax revenue in 2013-14, could not become part of the divisible pool due to a Constitutional provision; moreover these levies are for specific purposes.
For the horizontal distribution of tax devolution across States, the 14th FC mostly follows the previous FCs. Maximum weightage (50 per cent) has been given to the distance formula, or the difference between the actual per capita income of a State and the highest per capita income State, to supplement States with low fiscal capacity. Next comes population with both the 1971 and the 2011 Censuses being taken into consideration. According weight to the 2011 population helps capture demographic changes due to migration and age.
Finally, States have been incentivised to protect forests, which is a national good with huge ecological benefits though at the cost of economic activities for the states.
The FC has recommended ‘post-devolution revenue deficit grants’ for a total of ₹1,94,821 crore to 11 States on account of expenditure requirements, tax devolution and revenue mobilisation capacity of the states.
For fiscal decentralisation, the 14th FC recommended a grant of ₹2,87,436 crore to 2.5 lakh local governments comprising over three million elected representatives for the period 2015-20 compared to the 13th FC recommendation of ₹87,519 crore. The grants have two components — basic and performance based grants — which have fixed ratios of 90-10 and 80-20 for panchayats and municipalities, respectively. Since performance also determines transfer of grants, local governments will be evaluated on the basis of proper accounting, delivery services, own revenue mobilisation and so on.
The FC has also made recommendations on cooperative federalism, GST, fiscal consolidation roadmap, pricing of public utilities and public sector undertakings. In the case of GST, the commission does not advocate fixing the amount of compensation to the States but suggests the Centre initially bear an additional fiscal burden arising due to GST on the lines of compensation provided in the implementation of VAT. About the pricing of public utilities, it recommends measures to improve fiscal health and efficiency such as 100 per cent metering in electricity, drinking water and so on.
Implications The recommendation to make States’ share 42 per cent of the total divisible pool is historic. For example, if the transfers to States in the divisible pool is around 60 per cent, 42 per cent of this would constitute around 70 per cent of the total transfers through tax devolution, making it the primary source of resource transfers to States. By doing that, the 14th FC has achieved many goals at one shot. This will reduce the fiscal space of the Centre, preventing it from having an expansionary fiscal approach on a State subject. Together with grants in local bodies, grants-in-aid for 11 revenue-deficit States and share in coal auction means a huge increase in fiscal transfers. This would give States the fiscal space to design their own developmental schemes and programmes as suitable.
However, as reflected in the dissent note of panel member Abhijit Sen, the increase in the tax devolution share to 42 per cent would disrupt plan transfers. Some of the specific, centrally sponsored socio-economic programmes would get reduced funding or be closed down.
Already, eight out of the 66 CSS schemes have stopped getting funding from the Centre. Another 24 will see reduced funding and only 34 will get full funding henceforth. It’s not clear whether States will immediately compensate for withdrawal, in which case beneficiaries may be affected. Some schemes such as the backward regions grant fund, meant mostly for poor States, may suffer from this pruning of plan transfers. This has already happened in Budget 2015-16 in which the panchayati raj ministry has received negligible funds compared to earlier times.
Moreover, there is also apprehension about the use of money by States when there is no handholding. The quality and capacity of State administration varies widely, and therefore the increased untied fiscal transfers along with reduction in tied developmental plan schemes may lead to the misuse of money.
Well governed States with proper institutions and vision may prosper. Overall, the 14th FC minimised the conditions and incentives in transfers both from the Centre to States and States to local bodies, putting huge burden of trust on each layer of government, which is the symbol of true cooperative and competitive fiscal federalism. Now it’s time for the States to stand on their own and deliver.
The writer is an associate professor at the Institute of Economic Growth, Delhi