The Terms of Reference (ToR) of the 15th Finance Commission of India has drawn flak from southern states and Odisha as it uses population data from Census-2011 to decide the shares of taxes among states. States that have achieved replacement rate of population growth are worried they would greatly lose on revenues from the Union. But there is another major bone of contention in the ToR that may affect all states equally and compromise the federal character of the country.
In the ToR, the President has asked the 15th Finance Commission to propose measurable performance-based incentives for States in areas such as implementation of GST, checking population growth, implementation of Union government schemes, improvement in quality of expenditure, promoting digital economy, promoting ease of doing business, controlling populist measures, and implementation of Swachh Bharat Mission.
Article 280 of the Constitution empowers the President to constitute a finance commission to advise ways to distribute the net proceeds of taxes between the Union and states.
All the initial finance commissions were asked to perform their core functions as prescribed in the Constitution. In the recent decades, especially starting the 11th FC, these bodies have been asked to recommend measures to achieve fiscal discipline among states and the Union.
For first time in the history of finance commissions, the 11th FC was asked to recommend measures to “draw a monitorable fiscal reforms programme aimed at reduction of revenue deficit of states and to incentivise states to implement these reforms by providing Non Plan Revenue Deficit Grants”.
This led to the subsequent enactment of Fiscal Responsibility and Budget Management (FRBM) Act by the Union and state governments. Although enactment of FRBM Act has brought fiscal discipline among states, they have paid a heavy price for this, especially the poorer states.
To comply with FRBM, poorer states such as Odisha are not spending adequately on quality education and health services.
Despite such consequences, the 15th finance commission has been asked to recommend incentive schemes based on performance in areas not linked to achieving sound state finances.
In the recent years most state governments have complained that the Union Government has been gradually encroaching upon state subjects through various centrally-sponsored. This approach of the Centre will weaken the federal character of the nation.
Every state has its own model of development and needs to adopt its unique path to progress. There is considerable variation in the expectations of people of different states with regard to the level and nature of public services. The elected state government is in an advantageous position to understand their priorities and to fulfil them. States also argue they have acquired capabilities of designing strategies for development and have matured in terms of economic management.
Keeping these demands in view, the 14th FC had recommended devolution of more untied funds to state governments and an increase in the share of states in the net proceeds of revenue from 32 per cent to 42 per cent. This enables state governments to allocate money for public goods most preferred and demanded by the natives of the state.
The performance of a state depends not only on policy formulation and execution but also on structural character of the economy. For instance, the performance in tax revenue realisation not only depends on efficiency of the tax department but also on the structure of an economy, the share of organised and unorganised sector, share of primary, secondary and tertiary sectors and the deep-rooted habit of people to comply with tax laws. Overnight change in tax laws would seldom increase tax collection.
No state government in India can take direct credit for putting special efforts into controlling population. India is probably the only country worldwide to have a very good but unimplemented population policy. The states that boast to have achieved demographic transitions can barely take credit of enforcing the population policy. Level of human development, which has historical roots of differentiation, has played a major role in controlling population growth. Therefore, penalising states with high population growth would double burden on these states.
While transferring resources to states, the initial FCs used criteria that mostly reflected the need of the states (such as population, and geographical area) and contribution of the state to the revenue collection. However, gradually these criteria have changed. Multiple indicators of equity, efficiency and fiscal discipline have been used to transfer resources to states. State-specific requirements have been met through grants-in-aid. The 14th Finance Commission included the indicators of sustainable development (forest cover) in the tax devolution formula. The major feature of the 14th FC was the provision of maximum untied funds to states.
If the 15th FC, incorporates the incentivisation objective in the tax devolution formula, this would unnecessarily complicate the tax-sharing formula and make the untied funds virtually conditional. On the other hand, if it recommends special grants or grants-in-aid to incentivise states in all the performance indicators mentioned in the ToR, this would increase the component of conditional grants. It would curtail the freedom of states in designing their budget such that they meet regional needs.
In a federal country, the Union government should not assess performance of the state government. State heads are elected by their people and are answerable to them every five years. Therefore, the finance commission should provide maximum untied funds to states so that they have the freedom to provide public goods in demand. The finance commission, therefore, should focus on its core functions to devolve funds between the Union and states and among states and suggest measures that can ensure sound finances for states. It should recommend nothing more and nothing less than what is enshrined in the Constitution.
The writer is Assistant Professor of Economics, NISER, Bhubaneswar.