Finance Commission – Issues related to devolution of resources

[oped of the day] Firm steps to ease the fiscal federalism tension

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Fiscal federalism in India

Context

A “camel’s nose” is a metaphor to describe a situation where one permits a small entry to an outsider into one’s territory, only to be soon pushed out entirely. The fiscal relationship between the Centre and the States is fast turning into a “camel’s nose” syndrome for the States. 

Gaining entry to pushing out

  • Centre gained an entry through the GST into the territory of taxation powers of States.
  • It is now arming itself to elbow the States out entirely of its fiscal powers. 

Federalism

  • India is a union of States. Citizens of every State elect their government independently. 
  • The primary responsibility of such an elected government is efficient governance and accountability to its voters. 
  • An elected government is typically granted the powers to be able to raise revenues through taxation of its citizens and incur appropriate expenditure for their benefit.
  • Over the past five years, democratically elected State governments have been stripped of almost all powers of taxation.
  • There is an attempt to palm off the Centre’s expenditure obligation to the States and there is talk of even limiting expenditure powers of the States.

Lessons from the past : Meal scheme

  • In 1982, the newly elected Chief Minister of Tamil Nadu, MG Ramachandran (MGR) wanted to expand the midday meal programme to all 70 lakh children across 52,000 government schools to improve student enrolment. 
  • This entailed an additional expenditure of ₹150 crore, which the government did not have. 
  • MGR decided to levy an additional sales tax on goods sold in Tamil Nadu to cough up the amount needed. 
  • The programme was then further expanded by successive governments under the DMK. 
  • It catapulted Tamil Nadu’s literacy rate from 54% in 1981 to 83% in 2011. In just three decades, Tamil Nadu was counted as one of India’s most literate States.
  • MGR and other Chief Ministers of Tamil Nadu did not have to rush to New Delhi to make the decision to implement a midday meal programme and impose additional sales taxes to fund it. It was decided and approved in Chennai. 
  • In today’s India, MGR would have had to dash to Delhi and seek approval.

Fiscal federalism – goes against states

  • More than 80% of government’s revenues come from taxes, primarily from income tax (direct tax) and sales taxes (indirect tax). 
  • State governments in India do not have powers to levy income taxes. 
  • With GST, the Centre stuck its nose into the indirect taxes of State governments. States lost their sole powers to levy indirect taxes. 
  • Instead, they depend on a GST Council to determine tax rates and revenues.
  • A democratically elected State government in India can neither levy income tax nor sales tax. Effectively, it’s a representation without taxation.

Extending the intrusion into states’ domain – Defence

  • The Centre is now stretching its arms and legs to capture more. 
  • It has now proposed that there should be a permanent expenditure fund created for defence spending out of the total tax revenue pool. 
  • The Centre keeps 52% of the total tax revenue pool and distributes 48% to all the States and Union Territories. 
  • Instead of using its 52% share to spend on defence, the present government wants to palm off this expenditure to all the States. 
  • This will likely further reduce the tax revenues distributed to States for their own expenditure. 

Expenditure Council

  • There is now talk of constituting an Expenditure Council, similar to the GST Council. 
  • Not only did States lose their taxation powers but with this idea, they will lose its sole spending powers too. 
  • An elected Chief Minister of a State with no discretionary powers to earn or spend for the people of the State can virtually hand over the reins of governance to Delhi. 

Challenges

  • There is huge economic and cultural diversity among the various States. It is a terrible mistake to presume that all of India can be governed from Delhi.
  • Elected State governments and leaders cannot be made dummies without any fiscal powers for long. 
  • This fiscal federalism tension between the Centre and States can erupt into something more dangerous and spread wide.

Way ahead

  • Grant State governments the powers to levy income taxes. In large federal democracies such as the United States, State governments and even local governments have the right to levy income taxes. 
  • State governments should be given powers to raise revenues and incur expenditure in accordance with each State’s needs and priorities.
  • Amend the Constitution to grant States the powers to levy income taxes as they deem fit.

Conclusion

There is a distinction between unity and uniformity. Uniformity is not an essential condition for unity. On the contrary, a celebration of plurality may foster greater unity in a nation such as ours. The days of imperialistic London are over. It is the era of Gandhinagar, Chennai, Lucknow and Kolkata.

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