For several months now, the Terms of Reference (ToR) of the 15th Finance Commission (FC), which will cover a five-year period commencing 1 April 2020, has been at the centre of an economic debate in the country. The Finance Commission lays down the principles for giving out grant-in-aid to States and other local bodies and thereby seeks to ensure an equity in public service delivery across India. While a lot has been already written on the ToR by policy makers, politicians and academicians, this article briefly deals with a select few elements of ToR and how they could be tackled.
One of the striking changes in the ToR this time around is that the population is to be taken as per the Census 2011 rather than that of the 1971. That Census 1971 has been the basis for several FCs (last 10) and had the support of the National Development Council (NDC) is well known and so are the arguments favouring such an irrelevant and long-outdated statistical dataset as a foundational platform for such a critical exercise that will set the rules for revenue-sharing between the Centre and the States. It is a no brainer that the current population is the best basis, if population figures are to be considered to be the foundation for working out the ‘need’ of the States. At any rate for many other purposes (like using it for per capita distance calculation as well as the share computation of the Panchayati Raj Institutions (PRI) and Urban Local Bodies (ULB)), the earlier FCs, especially in recent times, have been using the latest available population figures.
Fear has been expressed that this change will lead to ‘losses’ for States that have delivered well in terms of population control and further that this will lead to a north-south divide. This argument is based on ‘Business As Usual’ scenario and a rather poor reckoning of the maturity and ability of the 15 FC members. Clearly, there are ways – reduction of weight to this criterion is an obvious one – in which the sudden jerky changes in State shares can be avoided on this count. In fact, the most important probable cause for the north-south divide is the fact that the FC this time has no representation from the south, thereby the optics of the composition of the FC is not well managed.
As far as the vertical proportion (share between Centre and States) is concerned, an increase in the States’ share to 42 percent was wrong headed. This was primarily a consequence of the misreading of the concept of cooperative federalism as well as assuming a certain amount of maturity of the State polity. In my judgement, the State bureaucrats and politicians both in terms of capacity and vision are rather more myopic as well as parochial when compared with their central counterparts. This implies that matters that concern environment as well as inter-generational issues are better handled by the central government. These are crucial concerns going forward which require considerable resources.
The logical fold-ins of many centrally-sponsored schemes (CSS) consequent to increasing the devolved proportion to the States and consequent squeezing of central budgetary support were not appreciated by the States. In fact, the ‘illusion’ of more flows led them – by all counts – to reduce their efforts to raise revenues, especially when perceived to be politically inconvenient. Without overestimating the capacity and vision at the Centre, one may hold that time is not ripe yet to completely give up a paternal attitude by the centre in the interest of the Union. It would, therefore, be prudent for the 15th FC to bring down the percentage to be devolved to the States from 42 percent to 36 percent; allowing for the inertial momentum intrinsic in historical experience of a two percent increase per FC. Whilst perchance redundant, there is an implicit nudge in the 15th FC ToR in this direction.
The 15th FC has been asked to take a call on the continuation or otherwise of the revenue deficit grants. Given the adoption of the Fiscal Responsibility and Budget Management Act (FRBM) and Fiscal Responsibility Legislations (FRL), there ought to be no revenue deficits to contend with. Now, we are privy to the history of States finding
clever ways of by-passing these. This is further compounded by the difficulty of estimating revenue deficits of the States (both because of capacity as well as an inherent complexity of the problem) that would pass the post-facto test of reasonability. Given all this and to avoid the danger of perverse incentive as well as a penalty to well-behaved States, the 15th FC should stop financing the States’ revenue deficit per se and find some ingenious solution to do this if it’s a constitutional requirement. Special issues of the States should be addressed on case-by-case basis to provide grants and relief to the States but not confined to – or indeed ignoring – revenue deficit considerations.
The matter of introducing incentive compatibility or addressing the issue of rewarding efficiency referred to in the ToR is perhaps redundant or may even be considered supercilious. The FC members clearly would have the sense and competence and should have the independence to do as they deem fit. But the wisdom of explicitly flagging it, especially after the rather stark experience (mostly negative) of the 14th FC, which, in its wisdom, gave a complete go by to the efficiency or the incentive compatibility criterion is imprudent. Efficiency or the incentive compatibility ideally should be the cornerstone of all right thinking economists in case of any policy design. Therefore, the argument should have been for an ever larger weight for efficiency criterion, proscribed by the political feasibility, in the devolution formula. This would also help allay the fears (arising out of the population base matter referred to earlier) of the better performing States.
Related to the above, but important in its own right, is the matter of measurement of per-capita income-distance criterion. This essentially entails that richer states get less allocation under this criterion and relative to the poorer ones judged on the basis of average measure of States’ income. Whilst the criterion is impeccable when it comes to logic, there are a couple things to consider. One, that the weight of over 50 percent should be significantly reduced and two, the distance should be measured from a disaggregated unit. This means that rather than using the State-level per-capita income, district-level income should be used. The last argument is based on the concern that while some of the richer States are categorised in the top States and hence, get next to nothing on account of this criterion, they have major issues arising out of huge inter-district inequality. Intra-state regional inequality is indeed concern of deprivation that surely warrants consideration.
Again, linked to this is the matter of regional imbalance in the States. Given that this is a politically-sensitive subject and one which has been dealt by the Centre via Parliament by providing Section 371(2) in the Constitution of India, it cannot be seen to be the State’s responsibility alone. Indeed, the Centre should put the money where its mouth is. This may indirectly satisfy those asking for ‘special’ status. Further, since in the current scenario, there is no other conduit to pass the resources from the Centre to the States, one may argue that for the time being, the FC should be used as an instrumentality for this purpose.
As we know, ‘the story of India has been considered to be story of her States’. This has been true for some time now, with intra-state issues incrementally assuming importance. Perhaps, time has come to add an addendum by saying that the story of India is now – and more so in the future – would be the story of her cities. The lack of empowerment and governance of cities as well as the role of States in this is well known. The last few FCs have taken cognisance of this and have started a quasi-direct dialogue with the local governments. Whilst remaining within the constitutional provisions, the 13th FC had provided a via media of a formulaic and hence, a buoyant, fund-flow from the FC to the local governments to the tune of 2.5 percent of the total fund to be devolved. This should be continue with added strength, say doubling of the formula in percent terms, forgetting the aberration of the 14th FC which went back to absolute magnitudes. The overall local bodies devolution should also be divided in the proportion of 40:60 (Urban:Rural) which would be forward looking and not penalise the more urban States.
On the matter of GST, the reference to it in the ToR is both meaningless and wrong- headed. This is especially so since we have an established and well-functioning GST Council that could and should be called upon to do what has been mentioned in the ToR. In the same category of ‘meaningless and wrong-headed’ is also the reference to back-casting the normative projections (which in addition is oxymoronic) and finally the reference to ‘populist measures’ which is connotatively deficient and hence, or otherwise, denotatively empty.
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