Resource transfers from the Centre account for over 40 per cent of the total revenue receipt of States and bulk of these transfers are based on the recommendations of the Finance Commission (FC), mandatorily constituted every five years. We analyse here the effect of the criteria used by FCs.
FCs uses various parameters to decide the share of each State in devolution of resources. These include need (population), cost (area), performance (tax/GSDP ratio), revenue foregone (forests and ecology) and capacity (to raise resources). Fiscal capacity has been the dominant parameter with weights assigned in excess of 40 per cent. It is determined on per capita income. It is computed from the highest per capita State income (excluding the small States of Goa and Sikkim) with population as the normalising factor. Such high weights to fiscal capacity induce bias in favour of poorer States, whose absorbing capacity of large resources is suspect.
The graph summarises the result of the weighting diagram used by the 15th FC (not substantially different from the weights that were assigned during the award period of earlier Commissions).
The outcomes
We now address the outcome of equity considerations in FC award.
On tax transfers to a State’s revenue receipts, the range is equally wide and varies from 12.5 per cent for Haryana to 69 per cent for Arunachal Pradesh. If we disregard the small and special category States, Bihar as a poor State has tax transfers equal to 58 per cent of its revenue receipt. Telengana, Tamil Nadu, Kerala, Karnataka, Maharashtra, Gujarat and Punjab had tax transfers less than 20 per cent of revenue receipt (in 2021-22, the latest year for which data is available). In Uttar Pradesh, Madhya Pradesh, Jharkhand and West Bengal tax transfers accounted for over 35 per cent of their revenue receipts. Equity considerations resulted in transferring a larger share from the Divisible Pool of taxes to poorer States.
As share of the FC, Uttar Pradesh, Bihar, Madhya Pradesh and West Bengal each obtained more than 7 per cent of funds compared to less than 1 per cent by some smaller States. More important, however, is the share in Divisible Pool relative to population. It is seen that better-off States like Haryana, Maharashtra, Telengana, Karnataka, Kerala, Gujarat and Punjab received less (proportion of total transfers) than their share in population at below 0.8. Some of these States suffered because of their success in controlling population, though the 15th FC did allocate a 12.5 per cent weightage to population management. Equity consideration enabled provision of larger resources to relatively poorer States.
The outcomes or impact on overall per capita income and share in GSDP, however, were not on accepted or desired lines. The per capita Net State Domestic Product (per capita income) continues to show no signs of convergence across States. The range of per capita income varies from a low of 33 per cent of the all-India average in Bihar to 3.19 times for Sikkim. The per capita income of Bihar has consistently been in the same range and greater transfers by way of equity considerations had hardly led to any convergence of income across States. Income levels have been at 80 per cent of the average income for Uttar Pradesh, Manipur, Jharkhand, Assam, Meghalaya, Madhya Pradesh and Chhattisgarh. They have been consistently higher for Tamil Nadu, Karnataka, Telengana and Haryana, in the range above 1.7 times the all-India average. While inter-State position has generally been sticky, West Bengal suffers erosion, from 1.25 times the national average in 1960-61 to 84 per cent in 2023-24.
The poorer States comprising Uttar Pradesh, Bihar, Rajasthan, Madhya Pradesh, Jharkhand, Chhattisgarh, Assam, Odisha and West Bengal in aggregate had a share in GSDP of 34.1 per cent while their share in transfers from Divisible Pool of taxes was 64 per cent. Leaving the smaller States, particularly the North-East States and Goa, the share in GSDP of other States was 58 per cent while they received a share in divisible pool of only 28 per cent. The share in GSDP and Divisible Pool across the two categories of States have virtually been static indicating that despite a larger share there was hardly any convergence. Hence in terms of equalising per capita income by improving their share in GSDP with a larger allocation, the equity criteria did not provide the desired results.
Another important issue relates to per capita revenue realisation by different categories of States. The primary objective of additional flow of resources was to compensate the States for their lower fiscal capacity or capacity to raise internal resources. Per capita revenue realised for Uttar Pradesh, Bihar, West Bengal, Jharkhand, Madhya Pradesh, Assam and Rajasthan was less than ₹270 in 2021-22, compared with per capita realisation of ₹300 and above for Andhra Pradesh, Telengana, Karnataka, Kerala and Maharashtra. The per capita resource availability is also a proxy for expenditure on social and economic services. Therefore, equity considerations failed in equalising expenditure on key services or realise adequate resources to fund their development initiatives and commitments.
Merit services
The equity consideration has been a mixed bag of success. The primary concern of equity consideration, as the 12th FC had observed, is to equalise revenue expenditure in critical merit services by direct intervention. The 14th FC had observed the need to grant adequate resources to ensure fulfilment of national priorities in health, education, drinking water and sanitation which have significant interstate externalities. Their signal is that the Centre must remain invested in these sectors. We hope that the 16th FC will give greater preference to them by increasing grant component for these sectors in its award reducing the weightage to equity criteria.
Gopalan is former Secretary, Economic Affairs, and Singhi is former Senior Economic Adviser, Ministry of Finance. Views are personal