The ToR of 15th Finance Commission of India has drawn enormous flak from the southern states and Odisha for its reference to use the 2011 population for sharing taxes among states. The states, that have achieved replacement rate of population growth, are worried of losing huge amount of revenue from the Union. However, there is another major bone of contention in this ToR which may affect all states equally and wane the federal character of the country.
In the Terms of Reference (ToR) the President of India has asked the 15th Finance Commission to propose measurable performance-based incentives for States in a number of areas like implementation of GST, checking population growth, implementation of schemes of Government of India, improvement in quality of expenditure, promoting digital economy, promoting ease of doing business, controlling populist measures, implementation of swatch Bharat mission and so on.
Article 280 of the Indian constitution empowers the President of India to constitute a Finance Commission to recommend him/her how to distribute between the Union and the States of the net proceeds of taxes and allocate between the States of the respective shares of such proceeds. The Finance Commission is also expected to recommend the principles which should govern the grants in aid of the revenues of the States and any other matter referred to the Commission by the President in the interests of sound finance.
All the initial Finance Commissions were asked to recommend mostly on its core functions as prescribed in the constitution. In the recent decades, especially starting from eleventh FC, the Finance Commissions have been asked to recommend measures to achieve fiscal discipline among the States and Union. For first time in the history of FC, in an additional ToR the eleventh FC was asked to recommend measures to “draw a monitorable fiscal reforms programme aimed at reduction of revenue deficit of the State” and incentivize states to implement these reforms by providing Non Plan Revenue Deficit Grants.
This led to the subsequent enactment of Fiscal Responsibility and Budget Management Act by the Union and State governments. Although enactment of FRBM Act has brought fiscal discipline among the states, states have paid a heavy price for this, especially the poorer states. In order to comply with the FRBM, poorer states like Odisha are not spending adequately for the provision of quality education and health services.
In spite of these severe consequences of incentivisation schemes, the fifteenth finance commission has been asked to recommend incentive schemes for the states based on performance in the areas that are no way linked to achieving sound finance of state. The question arises whether it is constitutionally tenable for the Finance Commission to recommend measures to assess the performance of states based on the indicators defined by the Union Government. This is unwarranted interference of the Union Government into the jurisdiction of the states which will reduce the autonomy of states in budget making.
In the recent years most of the state governments have complained that the Union Government has been gradually encroaching into the state subjects through various Centrally Sponsored Schemes, and Central Schemes. The paternalistic attitude of the centre would weaken the federal character of the nation as enshrined in the constitution.
Every state has its own model of development and hence need to adopt its unique path to progress. There is considerable variation in the expectations of the people of different States about the level and nature of public services. State government being elected representatives residing closer to their own people remain in advantageous position to understand their priorities and fulfill them. States also argue that they have acquired capabilities of designing their strategies for development and have matured in terms of economic management.
Keeping in view these demands from state governments, the fourteenth FC had recommended for devolution of more untied funds to the state government and increase the share of states in the net proceeds of revenue of the Union Government from 32 percent to 42 percent. This enables the state governments to allocate money for public goods most preferred and demanded by the natives of the state.
The performance of state depends not only on the policy formulation and execution but also the structural character of the economy. For example the performance in tax revenue realisation not only depend upon the efficiency of tax department but also the structure of an economy, the share of organized and unorganized sector, share of primary, secondary and tertiary sectors and the deep rooted habit of people to comply with tax laws. Overnight change in the tax laws would seldom increase the tax collection.
No state government in India can take direct credit of putting special efforts for controlling population. India is probably the only country in the world to have a very good population policy sans implementation. The states that boast to have achieved demographic transitions can barely take credit of enforcing the population policy and hence achieving the results. Level of human development, which has historical roots of differentiation, has played a major role in bringing down the population growth. Therefore, penalizing the states with high population growth would have double burden on these states.
While transferring resources to the 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 the states. State specific requirements have been met through grants-in aid. Fourteenth 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 incentivize the states in all the performance indicators mentioned in the ToR, this would increase the component of conditional grants. This would curtail the freedom of states in designing their budget suitable to meet their regional needs.
In a federal country, the Union government should not assess the performance of the state government. State heads are elected by its people and they are answerable to them in every five years. Therefore, the Finance Commission should provide maximum untied funds to the states to so that states have the freedom of providing the public goods demanded by its people. 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 are related to ensure sound finance of the states. It should recommend nothing more and nothing less as enshrined in the constitution.
Amarendra Das 