Originally Published 2020-07-24 10:24:09 Published on Jul 24, 2020
Sorry states

The myth of a dominant center and weak states in India is long enduring. Some of this is wish fulfillment by national elites since it reinforces their own centrality as Delhi based movers and shakers.

The “planned” economy approach, which ended in 2014 with the Modi government, also played to this tune by centralizing the doors which needed to be opened for private investment, preferential public investment in local areas or for favorable policy change in taxation and industrial regulation.

The Union government will always remain key for the core areas of the economy – national taxes account for about two thirds of the total tax paid by citizens; access to bank credit; access to overseas goods and financial markets; the exchange rate and national security.

But the wide disparity in “modern” performance metrics like fiscal deficit, own tax revenue, social indicators on education and health, the state of cities and the rule of law –shows that the quality of state level governance matters significantly for the quality of life.

On average, state governments got slightly less than one half (48%) of their revenue from the central government (RBI September 2019) per the sharing formula devised by the quinquennial Finance Commissions. In addition, some capital grants and loans are also provided by the Union government. The total transfer amounted to Rs 15.1 trillion last year (2019-20).

But some states are more fiscally autonomous than others if the share of central tax revenue in total receipts is taken as a metric. Delhi is an outlier with just 14% of its revenues coming from the Union.

Other states which derive less than one third of their revenues from the Union government are Telangana, Haryana, Maharashtra, Tamil Nadu, Gujarat and Goa followed closely by Karnataka.

The most dependent is Nagaland at 92% followed by the other six North Easter states. Bihar and J&K derive more than three fourths of revenue from the Union, followed closely with slightly less by Assam and Odisha.

Jharkhand, UP, West Bengal, MP, AP and Chhattisgarh are middle of the road with more than one half but less than 60% of their revenue coming from the Union Government.

The variation in Union government assistance is the key instrument for balancing out differences in institutional, infrastructure and natural resource endowments. The jury is out on whether the Finance Commission devolutions have done a good job over the past seven decades. But there does appear to be a direct correlation between multi-dimensional poverty and Union assistance.

The real test of State autonomy is whether the less dependent States have the fiscal capability to carve out their own developmental path independent of the Union government. Such autonomy might make sense in select areas.

Environmental policy is one such. Richer jurisdictions tend to value natural assets higher. They might want to pay a premium for retaining forest cover, fast-forwarding electric mobility, opting for renewable energy or gas power electricity generation.

Labor policy is another area where sticky pan-Indian laws on contracting make no sense. In states where investments are rising and employment levels are high there is little risk in diluting the harsh regulatory procedures for terminating jobs.

Similarly, taxing natural resources like land and water and created assets like built property higher makes sense where incomes are higher, farmers are well-endowed and urbanization levels are higher.

States which have a record of financial stability – the proxy for this metric is a revenue surplus or a negligible revenue deficit – can afford to keep their fiscal deficits higher because markets remain assured that they are good credit risks and would make good use of the borrowed money to generate revenue, unlike habitually spendthrift states who like to borrow and spend.

The real question is, despite such a rich tapestry of potential tax profiles, why do States not have policies and programs which differ on the ground? Take privatization of state-owned enterprises for instance. There is hardly any difference in the profile of state-owned enterprises between big, rich Maharashtra (annual per capita income Rs 186,000) and big, poor Uttar Pradesh (per capita income Rs 61,300).

Surely, with higher per capita income, markets become more lively enabling efficient private sector entities to replace stodgy state entities, releasing public funds for deployment elsewhere. Sadly, no such evolutionary path for States is immediately visible. The architecture of State governments, irrespective of size or income levels, is boringly monochromatic.

Consider also, the aspect of playing to one’s strengths in own revenue generation. UP with a much larger land area than Maharashtra collects just one forth as much land revenue at Rs 856 crore per year. Notably, both states have large areas devoted to cash crops like sugar cane.

Conversely Maharashtra collects revenue from stamps and registration of Rs 27,000 crores which is barely 40% more than what UP collects, even though land prices in rich Maharashtra are several times what they are in Uttar Pradesh.

Bottom line – UP taxes its rich farmers (dominant class) far too little. Maharashtra taxes its burgeoning middle class and the rich (dominant class) far too little as registration duty on land and property transfers.

Lazy tax policies, catering to the dominant classes in both states, inhibit incremental own-tax generation. Such biased tax policies also perpetuate the already existing income inequities worsening inequity.

In the post Covid-19 world, tax inefficiencies will impose a heavy cost on already strained state finances. State governments must review their own tax policies, using the filter of inequity and tax progression, to home in on incremental tax potential.

In order words there is no pot of gold to be discovered by continually bleeding segments which are already heavily taxed relative to income like the aspirational middle class, who pay both income and consumption tax, or the poor, who pay indirect taxes on their consumption expenditure. Latent tax potential can be discovered by balancing the aggregate tax incidence to income proportion, in favor of the poor and the “aspirational” middle-class.

Broadly, cutting back on tax exemptions for the well-off in land revenue, putting a higher carbon tax on dirty fossil fuels and high powered personal cars and taxis to push traffic to public transport, fixing electricity tariff at normative levels and collecting bills better, making the tax rate for land registration progressive, based on land value and limiting the concessional tax rate for women owners versus men, only to low value transfers, are some low hanging fruit to be exploited, pending a forensic review of hidden tax potential.

It is better to proactively rejig tax policy now, rather than being sorry later, by year end, when unsustainable, incremental state borrowing will be the only option to balance the budget in FY2021 and 2022.

This commentary originally appeared in The Times of India.

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Sanjeev Ahluwalia

Sanjeev Ahluwalia

Sanjeev S. Ahluwalia has core skills in institutional analysis, energy and economic regulation and public financial management backed by eight years of project management experience ...

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