Rebooting centre-state fiscal relations
THE 14th Finance Commission has sown the seeds of a radical overhaul of the existing fiscal relationship between the Centre and states. While the findings of the report are still under wraps, a sneak peak (mintne.ws/1FRg5iY ) shows that it has proposed that the states' share in central tax revenues be bumped up substantially to 42% from the existing level of 32%-this is the largest increase ever. (The states had lobbied the 13th Finance Commission, without success, for a 50% share in tax revenues.) This will be the second seminal reordering initiated by a Finance Commission.
The 10th Finance Commission had dumped the earlier practice of restricting sharing of resources only to a divisible pool made up of corporation tax and central excise duties. Instead, it proposed pooling of all central tax revenues, with the exception of surcharges and cesses. After the Constitution was duly amended, the 11th Finance Commission pegged the share of states at 29.5%, which has been upped progressively by subsequent commissions to its present level of 32%.
There is no precedent of a government rejecting the recommendations of a Finance Commission. So we can safely assume that this will go through. Before assessing the implications, it would be worthwhile to keep in mind that transfer of resources from the Centre to states takes place in two ways-statutorily and by executive order. The former takes place through the Finance Commission; and the non-statutory transfers are effected through the Planning Commission-a body that was created by an executive order-and central ministries (funding of centrally sponsored schemes implemented by states).
The states have, naturally, always preferred the statutorily ordained transfers. While statutory transfers are an entitlement protected by the Constitution, the residual resources are implicitly discretional and provide the union government potential leverage over statesespecially those with a different political hue.
The idea of the Finance Commission, a key institution in the federal governance structure, was to address an asymmetry between the taxation powers and functional responsibilities. While the Centre has greater taxation powers, the states, who oversee law and order, public health, sanitation, agriculture, education and building of roads and bridges, have far more functional responsibilities.
The commission's recommendations are meant to bridge the gap between the resources of states and the costs of funding its functional responsibilities. The recommendations of the 14th Finance Commission seem to coincide with another overhaul being attempted by the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) by extinguishing the Planning Commission (though the structure of the new body that has sprung up in its place seems, on first thoughts, a planning commission-lite). This, in turn, was preceded by another move that accelerated the process of streamlining centrally sponsored schemes and allowing states greater say in spending the budgets. In his first Union Budget, finance minister Arun Jaitley increased transfers to states for funding of centrally sponsored schemes by 50% to Rs.7.9 trillion.
To be sure, the first step in this direction, based on the Chaturvedi panel recommendations, was initiated by his predecessor P. Chidambaram. If we do connect the dots, it is apparent that a new paradigm is being etched in centre-state relations. Especially, if we also include the idea of a single goods and services tax (GST), which is likely to go through, bickering notwithstanding. With greater fiscal resources being devolved to states, its their relationship with the Centre is likely to be on a more even keel.
This is because the discretion vested with the union government will be severely diminished. This is something that should be welcomed as political scores cannot be settled by compromising economic potential. However, the downside of the move is that it presumes states do have the capacity to manage the enhanced resources. The development record, especially after the initiation of economic reforms since 1980 and its acceleration in 1991, is a matter of concern.