Finance Commission – Issues related to devolution of resources

Finance Commission dips into states’ share for Centre’s expenditure

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Finance Commission and its recommendations

Mains level : Paper 2- Fifteenth Finance Commission report and federalism

The article analyses the recommendations of fifteenth Finance Commission and their implications for the federalism in India.

Major recommendations accepted by the government

  • Report of the fifteenth Finance Commission (XVFC) was laid before the Parliament.
  • The finance minister announced the acceptance of its recommendation of retaining the share of states in central taxes at 42 per cent.
  • She also stated that on its recommendation revenue deficit grants of Rs 1.18 lakh crore to the states have been provided for in the budget.
  • Some of the recommendations, however, have far-reaching implications on government finances, both of the Centre and the states.
  • Keeping in view the extant strategic requirements for national defence in a global context, XVFC has, in its approach, recalibrated the relative shares of the Union and the states in gross revenues receipts.

Issues with the recalibration for national defence

  • Recalibration enables the Union to set aside resources for special funding on defence.
  • The states have been made to pay Rs 7,000 crore to bridge [the] Centre’s gap between projected budgetary requirements and budget allocation for defence and internal security defence.
  • But this is an expenditure that the Centre is obliged to fund.
  • For the first time, a finance commission has carved out resources meant for distributable statutory grants and dipped into the states’ revenue share, as against the tax share, in order to finance the Centre’s exclusive expenditure obligation.
  • What has been done is not in line with the system envisaged in the Constitution.
  • This move will eventually put the fiscal federal system under systemic strain.
  • In operational terms, too, this move is a significant departure.
  • So far, the Centre has been used to pre-empting resources from the kitty to be distributed among the states but only to finance expenditures in areas earmarked for states.
  • This was done through the centrally-sponsored schemes, but at least the states’ money was being used in the states, even if on a discretionary rather than a criteria basis.
  • Now, with this move of earmarking and financing of funds for sectors, it is the states’ money that is being used to finance the Centre’s expenditure.
  • This is certainly not cooperative federalism.

Changes in horizontal distribution: More weightage to efficiency and performance

  • In horizontal distribution, the criteria used by successive finance commissions for devolving taxes across states have always been linked to need — based on equity, tempered by efficiency.
  • From 92.5 per cent of funds to a state being devolved based on need and equity, the XVFC has reduced these two components to 75 per cent.
  • The remaining 25 per cent are to be devolved on considerations of efficiency and performance.
  • This is the lowest weightage for equity, making the XVFC transfers potentially the least progressive ever.

Structural changes not taken into account

  • The Finance Commission has not even made any serious effort to review the existing scheme of transfers in light of the changed federal landscape.
  • The existing criteria for the devolution have evolved in, and for, a production-based tax system.
  • The XVFC should have reformulated the distributional criteria for a consumption-based tax system [GST].
  • The structural change from production to consumption will make a significant difference to distribution as well as the need, nature and distribution of equalising grants.
  • This is the same manner in which the revenue deficit grants have been carried forward.
  • Ideally, the “gap-filling” approach should have been redesigned in light of the compensation law providing a minimum-guaranteed revenue of 14 per cent to every state.

Consider the question “For the first time, a finance commission has carved out resources meant for distributable statutory grants and dipped into the states’ revenue share, as against the tax share, in order to finance the Centre’s exclusive expenditure obligation. What are the issues with this move?”

Conclusion

The Fifteenth Finance Commission report is not aligned with the new landscape of federalism and does not address the key issues.

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