Mute Spectator : Fund Sharing
February 27, 2020
The fifteenth Finance Commission(FC) laid down its report on February 1st in Parliament and has received criticism from several stakeholders, especially from the southern states. FC is a constitutional body which is set up every five years as per article 280 of the Indian constitution. The report is supposed to give recommendation to the government, among other things, on the devolution of central funds to the states for a period of five years. The interim report published this year however deals only with the year 2020-21 and postpones the full report to the next year on account of the abrogation of article 370 and disintegration of J&K state into two Union Territories: J&K and Ladakh. We’ll look at the main takeaways from the report through this post.
Formula of Separation
Devolution of Central funds is always done through two ways; Vertical and Horizontal. Vertical devolution deals with the sharing between the Union government and all State governments put together while Horizontal devolution deals with the formula for sharing among the States. The 15th FC recommends 59% of the funds to the Union while the remaining 41% is allocated for the States. The states see a 1% decrease from the previous (14th FC) formula but this decrease essentially comes from the disintegration of J&K and does not provide for any significant change in the total corpus for States.
The Horizontal sharing among the states differ from commission to commission based on basic metrics like income distance, population, tax effort among others. These criteria can be clubbed under four divisions for further understanding; they are Needs to run the government, Equity among states, Efficiency of governance and Fiscal Performance. This report drafted its formula based on the 2011 census thereby deviating from previous FCs which primarily took 1971 census as their base.
Question of Incentives
The use of 1971 census data in previous FCs were rationalized on the account of uneven demographic performance among the states. They opined that if there is reduction of funds to states that took decent strides towards reducing population would be like incentivizing poor performance and disincentivizing good performance. But the obvious flaw in the argument is that it is out of touch with reality. As population grows, States with more population need more funds just to provide basic amenities to each individual. It forgets that the unit of measurement at the end of the day is of the individual and governments should provide comparable services at comparable tax rates to every individual irrespective of the state she is in. The 15th FC report however affirms its commitment to reality by using the 2011 census and also appreciates performing states with a special weightage on demographic performance; i.e, if states have reduced their fertility rates, they have an additional 12.5 % weightage in the formula.
The other problem of incentives deals with special sectoral grants which the FC recommends to each states on different sectors. The report recommends a special grant of Rs 7,375 crore on nutrition for 2020-21 and intimated that the full report will have other special grants for health, pre-primary education, judiciary, rural connectivity, railways, police training and housing. These incentives for states to spend on specific sectors has two problems; it is reminiscent of the central planning which the country is trying to forget where a central entity drafts the plan for the entire nation in an one size fits all approach and it has a big follow-up problem. The FC is not a permanent body therefore it would not be able to record and review the performance on such grants. This move towards sectoral grants is an unfortunate deviation from the 14th FC which abstained from such planning.
Winners and Losers
Five major states: Karnataka, Kerala, Andhra Pradesh, Telengana and Uttar Pradesh were named losers in all major news headlines. As mentioned earlier, the 41% is shared between the states with respect to the criteria discussed above; after such consideration, to compensate the states with poor performance and to satisfy the quest for Equity, some states get more and some get less. This is unavoidable in a diverse unevenly developed country like India. Let’s take the example of Karnataka and Bihar; Karnataka’s share has reduced from 1.98 out of 42% in the 14th FC to 1.49 out of 41% in the 15th FC, while that of Bihar’s has increased from 4.06 to 4.13 respectively. Now we’ll have to compare the perCapita income of both states; while PCI of Karnataka stands at Rs 1,78,12, PCI of Bihar is as low as Rs43,822. Considering the individual as the metric of comparison, individuals residing in Bihar should receive comparable services at comparable tax rates but they do not. So there should be equity of sharing, at least for now, to move towards a more equal society.
The concern of the ‘losing’ states, especially the southern states, are however very well justified. It seems like they are being punished with less funds for good performance. Although under-developed states must try to increase growth rates, blaming the FC for considering equity concerns is a zero sum game. Instead the 59% of the funds which is allocated for the Union government should be reduced and shared among the states. The Vertical formula must be revisited to give more power to states thereby putting money where the mouth is, otherwise the winner is always the Union and the losers- all the states put together.
Way Forward
There are a whole slew of Centrally Sponsored Schemes(CSS) which essentially deals with subjects on the State list and the Concurrent list. These schemes mostly overlap existing schemes in the states and are not required for the Union to step in. If the Union government has a moral obligation for the betterment of the society, let it give grants to the state as per article 275 of the Indian constitution rather than pushing political agenda on states. Direct Benefit Transfer is hailed as a successful measure for two reasons- empowering individuals to use their money in ways that they seem fit and reducing corruption; the same applies for grants straight to the states rather than CSS which is in a way, an antithesis to DBT.
The governments should oblige the FC and disclose all off-budget borrowings in order to properly arrive at the real value of fiscal performance. To review and follow up the recommendations, the FC should be made a permanent body with efficient members of judicial and economic proficiency. Looking towards the future, the FC should encourage and check the working of State FCs which decide on devolution of finances to local governments. The devolution to the local governments is much more important than state devolution because ultimately the individual is the basic unit of measurement and local governments are the closest to the individual.
By Benolin
Mute Spectator is the primary series of the blog where we express our thoughts on current affairs.
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